If the spot rate C$/$ is 1.4050 and the US interest rate is 5% and Canadian interest rate is 6%,

If the spot rate C$/$ is 1.4050 and the US interest rate is 5% and Canadian interest rate is 6%, then one-year equilibrium forward rate (C$/$) is

a) 1.4184 b) 1.3917 c) 1.4250 d) 1.3858

Solutions

Expert Solution

The Canadian interest rate will be growing by 6% and the US interest rate will be growing by 5%

The C$/$ means the Canadian dollar to dollar spot rate is given as 1.4050. So the forward exchange rate will also grow by the Canadian rate and get discounted by the US rate as it is a Canadian dollar to the US dollar exchange rate.

The formula for calculating the forward premium or foreign exchange rate is given by:

forward rate = spot rate x (1 + Canadian interest rate) / (1 + US interest rate) = 1.4050*(1.06/1.05) = 1.41838 or 1.4184(rounded)

jeff jeffy answered 2 years ago

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