Assume that U.S. interest rates for the next three years are 5 percent, 6 percent, and 7 percent, respectively. Also assume that Canadian interest rates for the next three years are 3 percent, 6 percent, and 9 percent. The current Canadian spot rate is $.840. What is the approximate three-year forecast of the Canadian dollar's spot rate if the three-year forward rate is used as a forecast?
A) $.840
B) $.890
C) $.856
D) $.854

Question

Quizplus · Accepted Answer

To use the three-year forward rate as a forecast, we need to calculate the forward rate for each year and then take the product of the three rates to get the three-year forward rate. The formula for calculating the forward rate is:

Forward rate = spot rate x (1 + foreign interest rate) / (1 + domestic interest rate)

Using this formula, we get the following forward rates for each of the three years:

Year 1: Forward rate = .840 x (1 + .03) / (1 + .05) = .824

Year 2: Forward rate = .840 x (1 + .06) / (1 + .06) = .840

Year 3: Forward rate = .840 x (1 + .09) / (1 + .07) = .874

Taking the product of these three rates, we get:

Three-year forward rate = .824 x .840 x .874 = .622

Therefore, the three-year forecast of the Canadian dollar's spot rate using the three-year forward rate as a forecast is approximately $.856. So, the correct answer is C.

Assume That U