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Hedging exchange rate risk (LO21-3) You are the vice president of finance for Exploratory Resources, headquartered in Houston, Texas. In January 2010, your firm’s Canadian subsidiary obtained a six-month loan of 150,000 Canadian dollars from a bank in Houston to finance the acquisition of a titanium mine in the province of Quebec. The loan will also be repaid in Canadian dollars. At the time of the loan, the spot exchange rate was U.S. $.8995/Canadian dollar and the Canadian currency was selling at a discount in the forward market. The June 2010 contract (Face value = C$150,000 per contract) was quoted at U.S. $0.8930/Canadian dollar.
a. Explain how the Houston 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?
Security A has an expected return of 8%t and a standard deviation of 20%. Security B has an expected return of 10% and a standard deviation of 50%.
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