Bank Canada Has Fixed-Rate Assets of $50 Million Funded by Fixed-Rate

Multiple Choice

Bank Canada has fixed-rate assets of $50 million funded by fixed-rate liabilities of 75 million Euros paying an interest rate of 10 percent annually. Bank Dresdner has fixed-rate assets of €75 million funded by fixed-rate liabilities of $50 million paying an interest rate of 10 percent annually. The current exchange rate is €1.50/$. They agree to swap interest payments on their liabilities to hedge against currency risk exposure for two years. At the end of the year 2, the exchange rate is €1/$. What are the losses and gains to each bank as a result of this swap. Ignore principal payments and compare it to the scenario where it did not engage in the swap.

A) With the agreement, Bank Dresdner pays €2.5 million less while Bank Canada pays $1.25 more.
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank Canada pays $2.5 million less.
C) With the agreement, Bank Canada pays $3.75 million less while Bank Dresdner pays €7.5 million more.
D) With the agreement, Bank Canada pays $3.75 million more while Bank Dresdner pays €7.5 million less.
E) Each bank pays the same because the exchange rate affects both parties equally