Your U.S.bank issues a one-year U.S.CD at 5 percent annual interest to finance a C $1.274 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually.You expect to liquidate your position in one year.Currently, 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

The position is exposed to interest rate risk because changes in interest rates can affect the value of both the U.S. CD and the Canadian bonds. It's exposed to exchange rate risk because the investment is in Canadian dollars and any fluctuation in the USD/CAD exchange rate can affect the value of the investment when converted back to U.S. dollars. Finally, it's exposed to credit risk because there's always a risk that the issuer of the Canadian bonds could default on their payments.

Your USBank Issues a One-Year U