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.
-What is the end-of-year profit or loss on the bank's cash position if in one year both Canadian bond rates increase to 7.5 percent and the exchange rate falls to US $0.765 per Canadian dollar (Assume no change in U.S. interest rates.) (Choose the closest answer)

Question

Quizplus · Accepted Answer

The correct answer is A.The bank will lose money on this transaction because the Canadian bond rates are expected to increase and the exchange rate is expected to fall. This will result in a lower return on the Canadian bond investment and a higher cost of the U.S. CD.

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