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. What is the end-of-year profit or loss to the bank if in one year the exchange rate falls to US $0.765 per Canadian dollar? (Assume that there is no change in interest rates.)

Question

Quizplus · Accepted Answer

To calculate the profit or loss, we need to convert the investment and the interest earned back to US dollars at the end of the year using the new exchange rate:

Investment: C $1.274 million x US $0.765/C$ = US $974,685
Interest earned: C $1.274 million x 7% = C $89,180 = US $68,382.73 (using the spot exchange rate)

Total proceeds: US $974,685 + US $68,382.73 = US $1,043,067.73

The bank paid out US $1,050,000 to the owner of the CD, so the end-of-year loss is:
US $1,050,000 - US $1,043,067.73 = US $6,932.27. This corresponds to answer choice C.

Your USBank Issues a One-Year U