You are the vice-president of finance for Exploratory Resources, headquartered in Calgary. In January 2012, your firm's American subsidiary obtained a six-month loan of $1 million (U.S.) from a bank in Calgary to finance the acquisition of an oil producing property in Oklahoma. The loan will also be repaid in U.S. dollars. At the time of the loan, the spot exchange rate was US$1.0125/C$ and the U.S. currency was selling at a premium in the forward market. The June 2012 futures contract (face value= $100,000 per contract) was quoted at US$1.0107.
a. Explain how the Calgary bank could lose on this transaction.
b. How much is the bank expected to lose/gain due to foreign exchange risk?
c. If there is a $100 total brokerage commission per contract, would you still recommend that the bank hedge in the currency futures market?