# Solved Question: Assume that a bank has assets located in London worth £150 million

## Description

Question:

Assume that a bank has assets located in London worth £150 million on which it earns an average of 8 percent per year. The bank has £100 million in liabilities on which it pays an average of 6 percent per year. The current spot exchange rate is £2/\$.

a. Given new exchange rate is £1.80/\$ what is the effect in dollars on the net interest income from the foreign assets and liabilities? Note: The net interest income is interest income minus interest expense

b.What is the effect of the exchange rate change on the value of assets and liabilities in dollars?

a) First compute the pound value of Interest and then convert it into dollars.

Interest Income in dollars (old exchange rate) = 150,000,000 x 8% / £2/\$ = \$6,000,000

Interest Income in dollars (New exchange rate) = 150,000,000 x 8% /£1.80/\$ = 6,666,666.67

Interest expense in dollars (old exchange rate) = 100,000,000 x 6% / £2/\$ = 3,000,000

Interest expense in dollars (New exchange rate) = 100,000,000 x 6% / £1.80/\$ = 3,333,333.33

Net Interest income (new) = 6,666,666.67 – 3,333,333.33 = 3,333,333.34

Net Interest income (old) = 6,000,000 – 3,000,000 = 3,000,000

Net effect = 3,333,333.34 – 3,000,000 = 333,333.34

b) Value of Assets in dollars (old) = £150,000,000 / £2/\$ = \$75,000,000

Value of liabilities in dollars (old) = £100,000,000 / £2/\$ = \$50,000,000

Value Assets in dollars (new) = £150,000,000 / £1.80/\$ = \$83,333,333.33

Value of liabilities in dollars (New) = £100,000,000/ £1.80/\$ = \$55,555,555.56

Effect on assets = 83,333,333.33 – 75,000,000 = \$8,333,333.33

Effect on liabilities = 55,555,555.56 – 50,000,000 = 5,555,555.56

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