Question

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.

Answer 1

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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