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. If in one year there is no change to either interest rates or exchange rates, what is the end-of-year profit or loss for the bank? (Hint: Annual interest is paid on both the Canadian bonds and the CD on the date of liquidation in exactly one year.)

Question

Quizplus · Accepted Answer

To calculate the profit or loss, we need to consider the interest earned on the Canadian bonds, the cost of the U.S. CD, and the exchange rate. The investment in Canadian bonds is C $1.274 million, which at a 7% annual interest rate will earn C $89,180 (1.274 million * 0.07) in one year. The cost of the U.S. CD is based on the exchange rate of US $0.78493 per Canadian dollar, so the U.S. dollar amount invested is $1.274 million * $0.78493 = US $1,000,000 approximately. The U.S. CD earns 5% interest, or US $50,000 (1,000,000 * 0.05) in one year. To compare the profits, we need to convert the Canadian bond interest back to U.S. dollars using the same exchange rate (assuming no change), which gives us US $89,180 * $0.78493 = US $70,000 approximately. The net profit is the interest earned on the Canadian bonds in U.S. dollars minus the interest paid on the U.S. CD, which is US $70,000 - US $50,000 = US $20,000.

Your USBank Issues a One-Year U