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Adjusting returns for exchange rates

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You are the vice president of finance for the International Resources, Inc. headquartered in Denver, Colorado. In January 2007, your firm's Canadian subsidiary obtained a six-month loan of $100,000 Canadian dollars from a bank in Denver to finance the acquisition of a titanium mine in Quebec province. The loan will also be repaid in Canadian dollas. At the time of the loan, the spot exchange rate was $0.8852/Canadian dollar and the Canadian currency was selling at a discount in the forward market. The June 2007 futures contract was quoted at US $0.8817.

a. Explain how the Denver bank could lose on this transaction if it does not hedge.

b. If the bank does hedge, what is the maximum amount it can lose?

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Solution Summary

The solution explains how to determine the gain or loss due to changes in exchange rates

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a. The bank is in the US and has given a loan in Canadian Dollars. If the bank does not hedge and the Canadian dollars depreciate, the bank would get less US Dollars for ...

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