The current spot rate is C$1.400 and the one-year forward rate is C$1.344. The nominal risk-free rate in Canada is 4 percent while it is 8 percent in the U.S. Using covered interest arbitrage,you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

Question

Quizplus · Accepted Answer

The profit is the difference between the interest earned on the covered investment and the interest earned on the uncovered investment. The interest earned on the covered investment is the risk-free rate in Canada, which is 4%. The interest earned on the uncovered investment is the risk-free rate in the U.S., which is 8%. The profit is therefore 4% - 8% = -4%. The profit is negative because the interest rate in the U.S. is higher than the interest rate in Canada.

The Current Spot Rate Is C$1