8. Suppose in the spot market 1 U.S. dollar equals 1.20 Canadian dollars. 6-mont

Question

8. Suppose in the spot market 1 U.S. dollar equals 1.20 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?

a. 1 U.S. dollar = 1.234 Canadian dollars b. 1 U.S. dollar = 1.197 Canadian dollars c. 1 U.S. dollar = 1.0000 Canadian dollars d. 1 U.S. dollar = 1.312 Canadian dollars e. 1 U.S. dollar = 1.469 Canadian dollars

Explanation / Answer

Answer: b. 1 U.S. dollar = 1.197 Canadian dollars

From the interest rate parity formula it follows that

=1.20CD *(1.03/1.0325)

=1.197 canadian dollars

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