Question

Suppose the spot exchange rate for the Canadian dollar is Can$1.15 and the six-month forward rate is Can$1.17.

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$3.00? (Round your answer to 3 decimal places, e.g., 32.161.)
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

a. a U.S. dollar is worth more because 1 U.S. dollar is equal to 1.15 Canadian dollar. in other words, 1 U.S. dollar will get you 1.15 Canadian dollar.

b. cost in the United States of an Elkhead beer = price in Canada/spot exchange rate = Can$3.00/Can$1.15 = 2.609 U.S. dollar

c. in six month, U.S. dollar is selling at a premium relative to the Canadian dollar in forward market because forward rate is higher than spot rate. as per forward rate, 1 U.S. dollar is equal to 1.17 Canadian dollar which is higher than spot rate.

d. U.S. dollar is expected to appreciate in value because forward rate for U.S. dollar is higher than spot rate.

e. Canada has higher interest rates because it is trading at discount relative to U.S. dollar in forward market.