4. Assume that bank has assets located in Germany worth €150 million earning an average of 8 percent. It also holds €100 in liabilities and pays an average of 6 percent per year. The current sot rate is €1.50 for $1. If the exchange rate at the end of the is €2.00 for $1, (LG 19-1)
a. What happened to the dollars? Did t appreciate or depreciate against the euro (€)?
b. What is the effect of the exchange rate change on the ne interest margin (interest received minus interest paid) in dollars from its foreign assets and liabilities?
c. What is the effect of the exchange rate change on the value of the assets and liabilities in dollars?
a. To determine if the dollar appreciated or depreciated against the euro, we need to compare the initial exchange rate of €1.50 for $1 with the final exchange rate of €2.00 for $1. By looking at these rates, we can say that the dollar appreciated against the euro because it now takes fewer dollars to buy one euro.
b. The net interest margin is the difference between the interest received from assets and the interest paid on liabilities. In this case, the bank's foreign assets are earning an average of 8 percent, while liabilities have an average interest rate of 6 percent. Since the interest rates remain the same, the change in the exchange rate does not directly affect the net interest margin in dollars.
c. The value of the assets and liabilities will change due to the exchange rate change. Since the dollar appreciated against the euro, the value of the assets denominated in euros will decrease when converted into dollars. In this case, the bank's assets of €150 million, when converted at the initial exchange rate of €1.50 for $1, would be equivalent to $225 million. However, if we use the final exchange rate of €2.00 for $1, the value of the assets would then be $300 million. Similarly, the liabilities worth €100 million would be $150 million at the initial exchange rate and $200 million at the final exchange rate.
Therefore, the exchange rate change results in an increase in the value of both assets and liabilities when expressed in dollars.