In this paper, the diffraction of water waves by a vertically floating cylinder in a two-layer fluid of a finite depth is studied. Analytical expressions for the hydrodynamic loads on the vertically floating cylinder are obtained by use of the method of eigenfunction expansions. The hydrodynamic loads on the vertically floating cylinder in a two-layer fluid inelude not only the surge, heave and pitch exciting forces due to the incident wave of the surface-wave mode, but also those due to the incident wave of the internal-wave mode. This is different from the case of a homogenous fluid. Some given examples show that, for a two-layer fluid system with a small density difference, the hydrodynamic loads for the surface-wave mode do not differ significantly from those due to surface waves in a single-layer fluid, but the hydrodynamic loads for the internal-wave mode are important over a wide range of frequencies. Moreover, also considered are the free surface and interface elevations generated by the diffraction wave due to the incident wave of the surface-wave and interhal-wave modes, and transfer of energy between modes.