Assume the current spot rate is CAD1.3250 and the 1-year forward rate is CAD1.3220. The nominal...

Assume the current spot rate is CAD1.3250 and the 1-year forward rate is CAD1.3220. The nominal risk-free rate in Canada is 2.25 percent while it is 2.1 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S. for one year.

Expert Solution


Forward rate= Canada dollar per USD * (1+Interest rate in Canada)/(1+Interest rate in USA)

Forward rate=	=1.325*(1+0.0225)/(1+0.021)
Per USD	1.3269

Since given forward rate is 1.3220, we can see that some arbitrage opportunity is available

So if the funds are invested in US	1*2.1%	$ 0.0210

So if the funds are invested in Canada, then funds available for investment are Canada dollar 1.325

Funds after 1 year	1.325*(1+2.25%)
Funds after 1 year	1.3548125
Forward rate	1.322
Funds converted back to USD	1.3548125/1.3220
Funds converted back to USD	$ 1.02482
Return earned	$ 0.02482

Additional profit	0.02482-0.0210
Additional profit	$ 0.00382

jeff jeffy answered 2 years ago

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