Question

Suppose the spot exchange rate for the Canadian dollar is Can$1.06 and the six-month forward rate is Can$1.08.
a.	Which is worth more, a U.S. dollar or a Canadian dollar?
b.	Assuming absolute PPP holds, what is the cost in the United States of an Elkhead beer if the price in Canada is Can$2.89? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
c.	Is the U.S. dollar selling at a premium or a discount relative to the Canadian dollar?
d.	Which currency is expected to appreciate in value?
e.	Which country do you think has higher interest rates—the United States or Canada?

Answer 1

ans a) US dollar has more worth because value of 1 USD = 1.06 can$

it means whatever we can purchase using only 1USD , if payment is done in terms of canadian dollar, you have to pay 1.06 can$ for same thing.

ans b) price of beer in Can$= 2.89 Can $

spot exchange rate is 1.06CAN $ / 1USD

OR 0.943 USD / 1 CAN $
price of beer in USD = 2.89CAN$ * 0.943 USD / 1 CAN $

=2.73 USD

C) AS DOLLAR PRICE in Forward market is greater than spot exchange rate (can$1.08/1 USD> can$1.06/ USD

dollar is said to be seeling at a premium

d)

as USD is seeling at premium it is likely to appreciate and Can $ is likely to depreciate

e)according to interest rate parity theory , exchange rate forward premiiums or discounts nulifies the difference between the interest rate between the two countries as they will not be able to earn arbitrage profit