Suppose the spot exchange rate for the Canadian dollar is Can$1.01 and the six-m

Question

Suppose the spot exchange rate for the Canadian dollar is Can$1.01 and the six-month forward rate is Can$1.03 a. Which is worth more, a U.S. dollar or a Canadian dollar? b. Assuming absolute PPP holds, what is the cost in the United States of an Elkhead beer if the price in Canada is Can$3.10? (Round your answer to 3 decimal places, e.g 32.161) c. Is the U.S. dollar selling at a premium or a discount relative to the Canadian dollar? d. Which currency is expected to appreciate in value? e. Which country do you think has higher interest rates-the United States or Canada? a. b. Cost in U.S. dollars d. e.

Explanation / Answer

(a) The given spot rate is CAD 1.01 for every 1 USD. Hence USD is worth more than CAD.

(b) Given the spot rate of 1.01 CAD for every 1 USD, as per PPP, the cost of Elkhead beer in US should be : 1.01 = Cost in Canada/Cost in US= 3.10/Price in US or solving we get Price in US = 3.069

(c) USD is selling at a premium

(d) USD is expected to appreciate since the forward rate of CAD moves from spot 1.01 to 1.03

(e) Canada - since the expected inflation is higher in Canada due to which its currency is depreciating

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