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 U.S.$0.78493 per Canadian dollar.

What is the end-of-year profit or loss to the bank if in one year Canadian bond rates increase to 7.538 percent? (Assume no change in either current U.S.interest rates or current exchange rates,U.S.$0.78493/C $1. )

Question

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 U.S.$0.78493 per Canadian dollar.

What is the end-of-year profit or loss to the bank if in one year Canadian bond rates increase to 7.538 percent? (Assume no change in either current U.S.interest rates or current exchange rates,U.S.$0.78493/C $1. )

Quizplus · Accepted Answer

Value of Canadian bond at year end
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Change in bond value = (C $1,267,607 - C $1,274,000) * 0.78493 = -C $6,392  0.78493 = Approx. -$5,000
 Previously established
 Profit (loss) = (U.S. $1,070,000) - (U.S. $1,000,000 * 1.05) = U.S. $20,000 less approximate change in bond value (-U.S. $5000)
 Overall profit (loss) = U.S. $15,000.

Your USBank Issues a One-Year U