The present exchange rate is C$ = U.S. $0.78. The 1-year future rate is C$ = U.S. $0.75. The yield on a 1-year U.S. bill is 5%. A yield of __________ on a 1-year Canadian bill will make investor indifferent between investing in the U.S. bill and the Canadian bill.

Question

Quizplus · Accepted Answer

To make investors indifferent, the return on the Canadian bill should compensate for the expected depreciation of the Canadian dollar. The expected depreciation is (0.78 - 0.75) / 0.78 = 3.85%. Adding this to the U.S. yield of 5% gives approximately 8.85%. The closest option is 9.2%.

The Present Exchange Rate Is C$ = U