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

Question

Question

Dollars six-month interest rate one-year interest rate

Canada 2% 2.5%

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?

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Answer 1

Answer #1

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.

Therefore, C$ Forward is trading at a Premium

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