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Question
Bank USA has fixed-rate assets of $50 million funded by fixed-rate liabilities of 75 million Euros paying an interest rate of 10 percent annually. Bank Dresdner has fixed-rate assets of 75 million funded by fixed-rate liabilities of $50 million paying an interest rate of 10 percent annually. The current exchange rate is 1.50/$. They agree to swap interest payments on their liabilities to hedge against currency risk exposure for two years.
At the end of the year, the exchange rate is €2/$. What are the losses and gains to each bank as a result of this swap compared to the scenario without the swap.
A. With the agreement, Bank Dresdner pays €2.5 million less while Bank USA pays $1.25 million more.
B. With the agreement, Bank Dresdner pays €2.5 million more while Bank USA pays $1.25 million less.
C. With the agreement, Bank USA pays $3.75 million less while Bank Dresdner pays €7.5 million more.
D. With the agreement, Bank USA pays $3.75 million more while Bank Dresdner pays €7.5 million less.
E. Each bank pays the same because the exchange rate affects both parties equally.
Answer
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