Question: Jones Bank has been borrowing in the U.S. markets and lending abroad, thereby incurring foreign exchange risk. In a recent transaction, it issued a one-year $5 million CD at 4 percent and is planning to fund a loan in yen at 6 percent for a 2 percent expected spread. The spot rate of U.S. dollars for Japanese yen is $0.001172/ ¥1.
a. However, new information now indicates that the yen will appreciate such that the spot rate of U.S. dollars for yen is 0.001155/ ¥1 by year-end. What should the bank charge on the loan in order to maintain the 2 percent spread?
b. The bank has an opportunity to hedge using one-year forward contracts at 0.001165 U.S. dollars for yen. What is the spread if the bank hedges its forward foreign exchange exposure?
c. How should the loan rates be increased to maintain the 2 percent spread if the bank intends to hedge its exposure using the forward rates?