Let\'s assume Colonel Sanders obtained a six-month loan of $150,000 Canadian dol
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Question
Let's assume Colonel Sanders obtained a six-month loan of $150,000 Canadian dollars from an American bank to finance the acquisition of a building for another Canadian franchise in Quebec province. The loan will be repaid in Canadian dollars. At the time of the loan, the spot exchange rate was U.S. $0.8995/Canadian dollar and the Canadian currency was selling at a discount in the forward market. The contract after six months (face value = C$150,000 per contract) was quoted at U.S. $0.8930/Canadian dollar.
Explain how the American bank could lose on this transaction assuming no hedging.
Assume the bank does hedge with the forward contract, what is the maximum amount it can lose?
Explanation / Answer
The Americam bank will now convert american dollars to canadian dollars and at the time of receving loan payment receive Canadian Dollars whixh again needs to be converted to American dollars..If Canadian dollar depreciates the Amerixan bank will lose.
In case of hedging the bank will short Canadian dollar forwards and hence the maximum loss=150000*(0.8995-0.893)=975 US dollars
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