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how a bank could lose on a transaction

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You are the Vice President of Finance for Daniel's Resources, headquartered in Phoenix, Arizona. In January 2002, your firm's Canadian subsidiary obtained a 6-month loan of 100,000 Canadian dollars from a bank in Tuscon, to finance the acquisition of a titanium mine in Quebec province. The loan will be repaid in Canadian dollars. At the time when Daniel's Resources obtained the loan, the spot exchange rate was USD $0.6580/$1 Canadian dollar and the currency was selling at a discount in the forward market. The June 2002 contract (face value = $100,000 USD per contract) was quoted at USD $0.6520/$1 Canadian dollar.

A) Explain how the Tuscon bank could lose on this transaction assuming no hedging.

B) If the bank does hedge with the forward contract, what is the maximum amount it can lose?

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The key statement in the question is that "The loan will be repaid in Canadian dollars.". This statement exposes the bank to risks associated with fluctuations in the foreign exchange market. Consider this scenario: the Canadian dollar (CAD) depreciates vs. United States ...

Solution Summary

This job argues how a bank could lose on a transaction.