The one-year CD rates for financial institutions with AA ratings are 5 percent in Canada and 8 percent in France. An AA-rated Canadian financial institution can borrow by issuing GICs or lend by purchasing GICs at these rates in either market. The current spot rate is $0.20/Euro. What should be the one-year forward rate in order to prevent any arbitrage?

Question

Quizplus · Accepted Answer

To prevent arbitrage, the forward rate should reflect the interest rate differential between the two countries. Using the interest rate parity formula: Forward Rate = Spot Rate * (1 + Interest Rate Domestic) / (1 + Interest Rate Foreign). Substituting the given values: Forward Rate = 0.20 * (1 + 0.05) / (1 + 0.08) = 0.1944/€.

The One-Year CD Rates for Financial Institutions with AA Ratings