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.
-If in one year there is no change in either interest rates or exchange rates, what is the end-of-year profit or loss of your bank's cash position? Assume that annual interest is paid on both the CD and the Canadian bonds on the date of liquidation in exactly one year.
A)Profit of US $20,000.
B)Loss of C $224,000
C)Profit of US $50,000.
D)Profit of C $63,000.
E)Profit of US $313,000.

Question

Quizplus · Accepted Answer

The bank earns 7% on the Canadian bonds, which is C $89,180 (7% of C $1.274 million). The exchange rate is US $0.78493 per Canadian dollar, so the interest earned in USD is US $70,180. The bank pays 5% interest on the US $1 million CD, which is US $50,000. The profit is US $70,180 - US $50,000 = US $20,180, approximately US $20,000.

A US Bank Issues a 1-Year, $1 Million U