Suppose that the spot rate on the Canadian dollar is C$1.40.The risk-free nominal rate in the U.S.is 8 percent while it is only 4 percent in Canada.Which one of the following one-year forward rates best establishes the approximate interest rate parity condition?

Question

Quizplus · Accepted Answer

According to the interest rate parity condition, the difference in interest rates between two countries should equal the percentage difference between the spot rate and the forward rate. In this case, the difference in interest rates is 8% - 4% = 4%. Therefore, the one-year forward rate should be C$1.40*(1+4%) = C$1.456. The closest option to this is option B, which has a one-year forward rate of C$1.344, making the percentage difference (C$1.344/C$1.40) - 1 = -3.8%. The difference in interest rates is approximately 4%, so this option is the closest to satisfying the interest rate parity condition.

Suppose That the Spot Rate on the Canadian Dollar Is