5. The current exchange rate between U.S. and Canadian dollars is 0.7 U.S. dollars

for each Canadian dollar. The one-year forward exchange rate is 0.72 U.S. dollars for each

Canadian dollar. The two-year forward exchange rate is 0.7 U.S. dollars for each Canadian

dollar. The continuously compounded interest rate in Canadian dollars is 6% (in Canadian

dollars).

(a) (10 points) What is the price of a one-year zero-coupon bond (face value $1,000) in the

United States? What is the one-year continuously-compounded interest rate? Same

questions for the two-year zero-coupon bond (face value $1,000).

(b) A U.S. bank that you work with is willing to sign a forward contract with

you in which you agree to invest $US 100 million in the bank in one year. A year later

(i.e. two years from now) you will receive $US 105 million. Alternatively you could sign

a forward contract with this same bank in which you borrow $US 100 million in one

year and repay $US 105 million in two years. Is there an arbitrage opportunity in the

market?