Suppose you observe the following spot and forward exchange rates between the U.

Question

Suppose you observe the following spot and forward exchange rates between the U.S. dollar ($) and the Canadian dollar (C$): Spot Exchange Rate 0.8842 One-Year Forward Exchange Rate 0.9001 Canadian dollar (U.S. dollar/Canadian dollar) The current one-year interest rate on U.S. Treasury securities is 6.35%. If interest rate parity holds, what is the expected yield on one-year Canadian securities of equal risk? O 4.47% O 5.14% 4.25% O 4.02% Interest rate parity recognizes that when you invest in a country other than your home country, two factors affect your investment-returns on the investment itself and changes in the exchange rate. Which of the following would cause the overall return on your investment to be lower than the investment's stated return? Your home currency appreciates relative to the currency in which the investment is denominated O The currency in which the investment is denominated appreciates relative to your home currency. Your home currency depreciates relative to the currency in which the investment is denominated.

Explanation / Answer

According to IRP:

present Exchange rate(USD/CAD)*(1+USD rate)/(1+CAD rate)= Future exchange rate

0.8842*1.0635/(1+CAD rate)=0.9001

CAD rate = 0.04471
Hence option first is correct
4.47%

If the currecny in which investment is made depreciates relative to home currency, then the remitences will be lower.
Looking at the options the first option is applicable becasue home currency appreciating is equivalent to foreign currency depreciating
hence first option is correct

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