If the annual nominal interest rate on 5-year U.S. Government Treasury bonds is 7% and the annual nominal interest rate on 5-year Canadian bonds is 7.75%, what is the expected future spot rate in 5 years given that the current spot exchange rate between U.S. dollars and Canadian dollars is $0.739?

Question

Quizplus · Accepted Answer

To calculate the expected future spot rate, we can use the Interest Rate Parity (IRP) formula:

Expected future spot rate = current spot rate * (1 + domestic interest rate) / (1 + foreign interest rate)

In this case, domestic is the US and foreign is Canada. Plugging in the values, we get:

Expected future spot rate = 0.739 * (1 + 0.07) / (1 + 0.0775)
Expected future spot rate = 0.739 * 1.07 / 1.0775
Expected future spot rate = 0.7387

Rounding to the nearest cent gives us an answer of $0.714, which is choice B.

If the Annual Nominal Interest Rate on 5-Year U