Cross-currency Loan Funding
An Exercise
Prof. Ian Giddy
New York University, Stern School of Business
Tel 212-998-0426; Fax 212-995-4233
E-mail: ian.giddy@nyu.edu Web: http://giddy.org
Dai-Ho Bank's funding choices
Dai-Ho Bank in HongKong needs to fund a U.S.-dollar loan. It obtains the following quotations: 3-month Eurodollars 5 1/4-5 1/8, 3-month Euroyen 2 3/4-2 11/16, Y/$ spot 105.55-105.65, 3 month forward points 0.049-0.052. Which is the cheapest way of funding the loan? Explain carefully how it would be done.
West LB Bank's deposit pricing
West LB Bank in London is currently quoting 8% on 12-month Eurodollars deposits. It is also quoting 5.20FF/$ and 5.45FF/$ for spot and 12-month forward French francs, respectively. If a customer asks for a quote on depositing French francs, what interest should the bank quote?
Answers
Dai-Ho Bank in HongKong needs to fund a U.S.-dollar loan. It obtains the following quotations: 3-month Eurodollars 5 1/4-5 1/8, 3-month Euroyen 2 3/4-2 11/16, Y/$ spot 105.55-105.65, 3 month forward points 0.049-0.052. Which is the cheapest way of funding the loan? Explain carefully how it would be done.
Dai-Ho needs to fund a U.S.-dollar loan. It could do this in two ways: (1) Borrow directly in the Eurodollar market at 5.25 percent or (2) Borrow in the Eurocurrency (here, Euroyen) market and then swap it into dollars. Let us investigate the second option a little further:
The bid rate on the 3-month Euroyen is 2.75 percent (i.e., Dai-Ho can borrow yen at 2.75 percent).
(a) The forward premium can be calculated as swap points/spot rate=0.052/105.65
(b) Effective cost of yen funding
=[(1+foreign interest rate)(1+forward premium)]-1
=
[(1+5.25/4)(1+0.052/105.65)]-1
=5.4495 percent.
Thus, it is cheaper for Dai-Ho to simply borrow directly in the Eurodollar market at 5.25 percent.aragraph
West LB Bank in London is currently quoting 8% on 12-month Eurodollars deposits. It is also quoting 5.20FF/$ and 5.45FF/$ for spot and 12-month forward French francs, respectively. If a customer asks for a quote on depositing French francs, what interest should the bank quote?
Intuitively, the dollar is worth more French francs in the forward market, so the Eurodollar interest rate should be lower than the Euro-French franc interest rate. Roughly, the interest differential equals the forward premium. The forward premium is .25/5.2=4.81%, so the French rate is about 5% higher than the U.S. dollar rate.
Specifically, the link between spot and forward rates and Eurocurrency rates is given by the interest-rate-parity theorem:
Solving for the Euro-French franc interest rate:
Go to Giddy's Web Portal • Contact Ian Giddy at ian.giddy@nyu.edu
Copyright ©2001 Ian Giddy. All rights reserved.