Question

Suppose that the risk-free rates in the United States and in Canada are 5% and 3%, respectively. The spot exchange rate between the dollar and the Canadian dollar (C$) is $0.80/C$. What should the futures price of the C$ for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs.

Answer 1

Answer:

The futures price of the C$ should be 0.82/C$.

Explanation:

Let:

rUS = Risk-free rates in the United States = 5%

rC = Risk-free rates in Canada = 3%

S = Spot exchange rate = $0.80/C$

Since the rUS is greater than rC, we have:

Future price of C$ = S + ((rUS -rC) * S) = 0.80 + ((5% - 3%) * 0.80) = 0.80 + (2% * 0.80) = 0.80 + 0.016 = 0.816, or 0.82

Therefore, the futures price of the C$ should be 0.82/C$.