Suppose in the spot market 1 U.S. dollar equals 1.0613 Canadian dollars. 6-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 U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?

Question

Quizplus · Accepted Answer

Interest rate parity implies that the forward exchange rate should adjust to offset the interest rate differential between two countries. Using the formula for interest rate parity: Forward Rate = Spot Rate * (1 + Interest Rate Domestic) / (1 + Interest Rate Foreign). Substituting the given values: Forward Rate = 1.0613 * (1 + 0.0325) / (1 + 0.03) = 1.0587 Canadian dollars.

Suppose in the Spot Market 1 U