Suppose in the spot market 1 U.S. dollar equals 1.75 Canadian dollars. 6-month Canadian securities have an annualized return of 6% 6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market? In other words, how many Canadian dollars are required to purchase one U.S. dollar in the 180-day forward market?

Question

Quizplus · Accepted Answer

Interest rate parity implies that the forward exchange rate should adjust to offset the interest rate differential between two countries. The formula for the forward rate is: Forward Rate = Spot Rate * (1 + Interest Rate of Domestic Currency) / (1 + Interest Rate of Foreign Currency). Using the given rates, Forward Rate = 1.75 * (1 + 0.0325) / (1 + 0.03) = 1.7458.

Suppose in the Spot Market 1 U