Question

# Suppose 1 U.S. dollar equals 1.55 Canadian dollars in the spot market. 6-month Canadian securities have...

Suppose 1 U.S. dollar equals 1.55 Canadian dollars in the spot market. 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? Enter your answer rounded to four decimal places. For example, if your answer is 12.34567 then enter as 12.3457 in the answer box.

A) we can compute the justified forward C\$ / \$ from the following formula :-

Justified forward rate = spot rate*(1+t*iC\$) / (1+t*i\$)

where t=period= 6 months

i\$ = 6.5%*6 / 12 =3.25%

spot rate = C\$1.55/ \$

iC\$ = 6%*6 / 12 =3%

Note :-180 day is treated as 6 month

= spot rate*(1+t*iC\$) / (1+t*i\$)

= 1.55 * (1+(6/12)*0.06) / (1+(6/12)*0.065

= 1.55*1.03 / 1.0325

180 day forward rate = 1.5462

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