Question

The £ is worth 1.2569 euros and the euro is worth $1.5568. Statistical analysis indicates that when the euro rises 1 percent against the dollar, the pound rises 0.5 percent against the euro and vice versa. A U.S. bank has assets of £40 million that mature in one year funded with liabilities of €55 million due in six months. The bank would be hurt by

I. an increase in the value of the euro against the dollar.
II. a decrease in the value of the euro against the dollar.
III. an increase in euro interest rates relative to pound interest rates.
IV. an increase in pound interest rates relative to euro interest rates

Answer 1

The bank would be hurt by:

• an increase in the value of the euro against the dollar
• an increase in euro interest rates relative to pound interest rates

Explanation:

The euro value of the assets = £40 x 1.2569 = €50.277 M

The bank therefore has a net debt exposure to currency that jeopardizes the value of the euro compared to the dollar.

When pound reserves accumulate for one year, and the euro's liabilities maturity in six months, the Bank's interest rates compared to pound are facing rising in euros.