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. What is the end-of-year profit or loss on the bank's cash position if in one year the exchange rate falls to US $0.765/C $1? Assume there is no change in interest rates.(Choose the closest answer)
A)Loss of US $75,000.
B)Profit of C $274,000.
C)Loss of US $7,000.
D)Profit of C $9,000.
E)Loss of US $5,000.

Question

Quizplus · Accepted Answer

First, let's calculate the expected cash flows at the end of the year:

- The CD will mature at $1 million + 5% = $1,050,000 USD
- The Canadian bonds will pay $1,274,000 CAD x 7% = $89,180 CAD
- To convert the CAD to USD, we use the spot exchange rate: $89,180 CAD x $0.78493/1 CAD = $69,926.01 USD

Therefore, the total expected cash flows are $1,119,926.01 USD.

If the exchange rate falls to $0.765/C$1 at the end of the year, then the value of the CAD proceeds will be:

$89,180 CAD x $0.765/1 CAD = $68,200.70 USD

The total cash flows in USD will therefore be $1,050,000 + $68,200.70 = $1,118,200.70 USD.

The bank's initial cash position was $1 million USD, so the profit or loss is:

$1,118,200.70 - $1,000,000 = -$118,200.70 USD

Converted to CAD, this is:

-$118,200.70/ $0.765/C$1 = -C$154,216.25

So the answer is C, a loss of US $7,000.

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