Given the following: US 90day interest rate 5% Canadian 90day interest rate 10%
ID: 2761460 • Letter: G
Question
Given the following: US 90day interest rate 5% Canadian 90day interest rate 10% Current Spot Rate $0.8512/C$ 90day Forward Rate $0.8501/C$ You have $1 Million and would like to engage in CIA: i) Outline the steps for CIA with the appropriate computation thereof and compute the profit. ii) Compute the Return on Investment of $1 million and identify its components: a) Interest Rate Component and b) Exchange Gain/Loss Component iii) For Interest Rate Parity to prevail, what should be the forward rate of the C$?
Explanation / Answer
Interest rate in U.S for 90 days =5%.
Interest rate in Canada for 90 days =10%.
Given current spot rate =$0.8512/C$.
90 days Forward rate =$0.8501/C$.
Answer for question no.a:
Interest component
Amount available in US dollars =$1,000,000.
When exchanged with Canadian dollars, amount obtained in canadian dollars =$1,000,000 *0.8512
=$851,200.
The funds are deposited at 10%.
So, interest earned =$851,200 *10%*90/365
=$20,988.49.
And, again the canadian currency is convered into US dollars at the end of 90 days ie., $851,200.+$20,988.49.canadian dollars.
=$872,188.49 canadian dollars.
After 90 days one US $ =$0.8501 canadian dollar.
Therefore, US dollars obtained after 90 days =$872,188.49/0.8501
=$1,025,983.41.
In case the same funds are deposited in U.S. Interest rate=5%.
Interest earned on 90 days deposit=$1,000,000 * 5%*90/365.
=$12,328.77.
Return on investment =$25,983.41/$1,000,000
=2.60%. is the return earned for 90 days.
Interest rate is 5% per annum, it means interest rate for 90 days =5%/365*90
=1.23%.
So,interest component would be 1.23%, and the balance is the gain for the exchange rate =$2.60 -1.23%
=1.37%.
Answer for question no.iii:
Formula is forward rate/Spot rate = (1+ us interest rate)/(1+Canadian interest rate)
forward rate/0.8512 =(1+5%*90/365)/(1+10%*90/365)
forward rate/0.8512 =1.0123/1.02465
Forward rate = $0.8410
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.