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 100,000 Canadian dollars from a bank in Houston to finance the acquisition of a titanium mine in Quebec province. The loan will also be repaid in Canadian dollars. At the time of the loan, the spot exchange rate was U.S. $0.8990/Canadian dollar and the Canadian currency was selling at a discount in the forward market. The June 2010 contract (Face value = $100,000 per contract) was quoted at U.S. $0.8920/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?