Explanation:
The bank lent USD5,000,000 × 1.12 = EUR5,600,000 to its German client. At the end of the year, the client repaid, with interest, 5,600,000 × 1.06 = EUR5,936,000, which was then worth USD5,936,000 / 0.84 = USD7,066,667. The bank repaid USD5,000,000 × 1.045 = USD5,225,000, including interest on its borrowed money, which generated a return of (7,066,667 − 5,225,000) / 5,000,000 = 36.8% on the loan. Alternate method: (1.12 / 0.84)(1.06) − 1.045 = 0.368.
(Book 3, Module 35.2, LO 35.h)
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Question 41
A bank borrows USD5 million at 4.5%, purchases euros on the spot market, and lends that amount to a German firm at 6%. The euro spot rate is 1.12 EUR per USD. After one year, the exchange rate is 0.84 EUR per USD. The rate of return on this loan to the bank is closest to:
A
1.5%.
B
3.5%.
C
36.8%.
D
77.8%.
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