Question 11 Suppose in the spot market 1 U.S. dollar equals 1.60 Canadian dollar

Question

Question 11

Suppose in the spot market 1 U.S. dollar equals 1.60 Canadian dollars. 6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%). 6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?
Answer 1 U.S. dollar = 0.6235 Canadian dollars
1 U.S. dollar = 0.6265 Canadian dollars
1 U.S. dollar = 1.0000 Canadian dollars
1 U.S. dollar = 1.5961 Canadian dollars
1 U.S. dollar = 1.6039 Canadian dollars

Explanation / Answer

Canadian dollar/ USD = 1.60

180 day forward market exchange rate = CAD (1+CAD interestrate)/(1+USD interest rate)

180 day forward market exchange rate = 1.60 (1+0.03)/(1+0.0325) = $1.5961 answer

Answer is (d) 1 U.S. dollar = 1.5961 Canadian dollars

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