The spot rate on the Canadian dollar is C$1.1578. The risk-free nominal rate in the U.S. is 7 percent while it is only 5 percent in Canada. What one-year forward rate will create interest rate parity?

Question

Quizplus · Accepted Answer

Interest rate parity implies that the forward rate should be such that the expected return on a one-year investment in either country is the same. In this case, the expected return on a one-year investment in the U.S. is 7%, while the expected return on a one-year investment in Canada is 5%. Therefore, the forward rate should be such that the expected return on a one-year investment in Canada is also 7%. This implies that the forward rate should be C$1.1362.

The Spot Rate on the Canadian Dollar Is C$1