A U.S.bank issues a 1-year, $1 million U.S.CD at 5 percent annual interest to finance a C $1.274 million investment in 2-year fixed-rate Canadian bonds selling at par and paying 7 percent annually.You expect to liquidate your position in 1 year upon maturity of the CD.Spot exchange rates are US $0.78493 per Canadian dollar. Your position is exposed to:
A)interest rate risk only.
B)credit risk only.
C)exchange rate risk only.
D)interest rate and exchange rate risk only.
E)interest rate risk, exchange rate risk, and credit risk.

Question

Quizplus · Accepted Answer

This position is exposed to interest rate risk because the interest rates could change, affecting the return on the Canadian bonds and the cost of the CD. It's exposed to exchange rate risk because the value of the Canadian dollar relative to the U.S. dollar could change, affecting the return when converting investment proceeds back to USD. It's also exposed to credit risk because there's a risk that the issuer of the Canadian bonds could default.

A USBank Issues a 1-Year, $1 Million U