Question

The spot exchange rate for Canadian dollars is \$C1.33/\$US.

Dollars                six-month interest rate               one-year interest rate

U.S.                                   2.5%                                              2.75%

a. What is the six-month fair forward exchange rate?

b. Is the Canadian dollar a discount or premium currency vs. the United States dollar?

c. What does it cost in U.S. dollars to purchase \$C1,000 now?

d. How many Canadian dollars will you receive by entering a six-month forward contract to sell \$1,000?

e. What will it cost in Canadian dollars to purchase \$US1,000 in six months via a forward contract?

a)

As per Interest Rate Parity,

Theoretical Forward Rate C\$/\$ = Spot C\$/\$*(1+Interest Rate on C\$)/(1+Interest Rate on \$)

= 1.33*[1+(0.02/2)]/[1+(0.025/2)]

= C\$1.3267/\$

b)

Less C\$ can be purchased for \$1 after 6-months than now.

c)

Current Cost to Buy C\$1000 = C\$1000*(Spot \$/C\$) = C\$1000/(Spot C\$/\$) = 1000/1.33 = \$751.8797

d)

C\$ receivable on selling \$1000 in 6-month forward = (Forward C\$/\$)*\$1000 = 1.3267*1000 = C\$1326.7

e)

6-month Forward Cost to Buy C\$1000 = C\$1000*(Forward \$/C\$) = C\$1000/(Forward C\$/\$) = 1000/1.3267 = \$753.7499

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