Answer to Question #33365 in Economics of Enterprise for John Smith

Question

Suppose 1 U.S. dollar equals 1.60 Canadian dollars in the spot market. 6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%). 6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?

Answer 1

1 U.S. dollar = 1.5961 Canadian dollars
The difference between securities return for 6 month is (3.25% - 3%) = 0.25%
So, the exchange rate will be: 1.6*0.9975 = 1.5961