Suppose in the spot market 1 US dollar equals 1.0613 Canadian dollars.Six-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%).6-month U.S.securities have an annualized return of 6.5% and a periodic return of 3.25%.If interest rate parity holds,what is the US dollar-Canadian dollar exchange rate in the 180-day forward market?

Question

Quizplus · Accepted Answer

According to interest rate parity, the forward exchange rate between two currencies should be equal to the ratio of the interest rates of the two countries.

Therefore, (1 + 0.065/2) / (1 + 0.03/2) = (forward exchange rate) / 1.0613

Solving for the forward exchange rate, we get:

Forward exchange rate = 1.0613 x (1 + 0.065/2) / (1 + 0.03/2) = 1.0587

Therefore, 1 US dollar is equal to 1.0587 Canadian dollars in the 180-day forward market.

Suppose in the Spot Market 1 US Dollar Equals 1