If the rate of return is 3 percent in Mexico and 8 percent in Canada, the

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Quizplus · Accepted Answer

According to the interest rate parity theory, the difference in interest rates between two countries is equal to the expected change in the exchange rate over time. In this case, since the interest rate is higher in Canada than Mexico, the Canadian dollar is expected to appreciate against the Mexican peso. The extent of appreciation can be calculated by subtracting the lower interest rate (3 percent in Mexico) from the higher interest rate (8 percent in Canada), giving a difference of 5 percent. Therefore, the Mexican peso is expected to appreciate against the Canadian dollar by 5 percent.

If the Rate of Return Is 3 Percent in Mexico