A U.S. bank issues a one-year U.S. CD (certificate of deposit) at 5 percent annual interest to finance a C $1.321 million (Canadian dollar) investment in two-year, fixed rate Canadian bonds selling at par and paying 7 percent annually. The bank expects to liquidate the position in one year. Currently, spot exchange rates are U.S. $0.7572 per Canadian dollar.

1.(a)Briefly characterize the risks the position exposes the bank to. No calculations required in this part of Question 3.

2.(b)If in one year there is no change to either interest rates or exchange rates, calculate the end-of-year profit or loss for the bank. Assume that annual interest is paid on both the Canadian bonds and the CD on the date of liquidation in exactly one year.

3.(c)Calculate the end-of-year profit or loss to the bank if in one year the exchange rate falls to U.S. $0.7351 per Canadian dollar. Assume that there is no change in interest rates.

4.(d)Calculate the end-of-year profit or loss to the bank if in one year Canadian bond yields increase to 7.535 percent. Assume no change in either current U.S. interest rates or current exchange rates, U.S. $0.7572/C $1.