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

The bank will receive C $89,180 in interest on the Canadian bonds and pay US $63,700 in interest on the CD. The bank will also receive C $1.274 million from the maturity of the bonds and pay US $1.000 million from the maturity of the CD. The net profit is C $89,180 + C $1.274 million - US $63,700 - US $1.000 million = C $225,480. At the current exchange rate, this is equivalent to US $176,000.

Your US Bank Issues a One-Year U