Cardinal Company, a U.S.-based insurance company, considers purchasing bonds denominated in Canadian dollars, with a maturity of six years, a par value of C$50 million, and a coupon rate of 12 percent. The bonds can be purchased at par by Cardinal and would be sold four years from now. The current exchange rate of the Canadian dollar is $0.80. Cardinal expects that the required return by Canadian investors on these bonds four years from now will be 9 percent. If Cardinal purchases the bonds, it will sell them in the Canadian secondary market four years from now. The exchange rates are forecast as follows:

Year __________________Exchange Rate of C$

1 ...................................... $0.80

2 ......................................0.77

3 ......................................0.74

4 ......................................0.72

5 ......................................0.68

6 ......................................0.66

a. Refer to earlier examples in this chapter to determine the expected U.S. dollar cash flows to Cardinal over the next four years. Refer to Chapter 3 to determine the present value of a bond.

b. Does Cardinal expect to be favorably or adversely affected by the interest rate risk? Explain.

c. Does Cardinal expect to be favorably or adversely affected by exchange rate risk? Explain.