Severus Co. has to pay 5 million Canadian dollars for supplies it recently received from Canada. Today, the Canadian dollar has appreciated by 2 percent against the U.S. dollar. Severus has determined that whenever the Canadian dollar appreciates against the U.S. dollar by more than 1 percent, it experiences a reversal of 40 percent on the following day. Based on this information, the Canadian dollar is expected to ____ tomorrow, and Severus would prefer to make payment ____.

Question

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If the Canadian dollar appreciates by 2 percent, its new exchange rate would be 1.02 CAD/USD. To pay its suppliers, Severus Co. would have to exchange 5 million CAD for USD, which would cost 5 million CAD / 1.02 CAD/USD = $4,901,961. If the Canadian dollar then depreciates by 0.8 percent, its new exchange rate would be 1.008 CAD/USD. Severus Co. would then receive a reversal of 40 percent, so its effective exchange rate would be 1.008 CAD/USD * (1 - 0.4) = 0.6048 CAD/USD. The cost of converting 5 million CAD at this exchange rate would be $3,024,000, which is less than the cost of converting the CAD today. Therefore, it is preferable for Severus Co. to make payment tomorrow.