The current exchange rate for the Canadian dollar is $.91US. The inflation rate in the U.S. is 2.5% while it is 3.5% in Canada. What is the expected spot rate in two years?

Question

Quizplus · Accepted Answer

The expected spot rate can be calculated using the International Fisher Effect, which suggests that the currency of the country with a higher inflation rate will depreciate. The formula is S1 = S0 * (1 + i_foreign) / (1 + i_domestic), where S1 is the expected spot rate, S0 is the current spot rate, i_foreign is the inflation rate of the foreign country (Canada), and i_domestic is the inflation rate of the domestic country (U.S.). Plugging in the values: $.91 * (1 + 0.035) / (1 + 0.025) = $.91 * 1.035 / 1.025 ≈ $.93.

The Current Exchange Rate for the Canadian Dollar Is