In the spot market, 1 U.S. dollar equals 1.60 Canadian dollars. 6-month Canadian securities have an annualized return of 6 percent (and therefore have a 6-month periodic return equal to 3 percent). 6-month U.S. securities have an annualized return of 6.5 percent and a periodic return of 3.25 percent. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?

Question

Quizplus · Accepted Answer

Interest rate parity implies that the forward exchange rate should offset the interest rate differential between two countries. Using the formula for forward rate: Forward Rate = Spot Rate * (1 + Interest Rate Domestic) / (1 + Interest Rate Foreign), we get 1.60 * (1 + 0.0325) / (1 + 0.03) = 1.5961 Canadian dollars.

In the Spot Market, 1 U