Question

Suppose the spot exchange rate for the Canadian dollar is Can$1.12 and the six-month forward rate is Can$1.14.

Answer 1

Answer:

Explanation:

Given that:

a)

1$ = Can $1.12

It takes a value of 1 U.S dollar to have 1.12 Canadian dollars.  This signifies that the U.S dollar is worth more than Canadian dollars.

b)

Assuming that the absolute Purchasing Power Parity PPP holds,

Since 1$ = Can $1.12, the cost  in the United States of an Elkhead beer, if the price in Canada is Can$2.85 can be determined to be:

= $\dfrac{2.85}{1.12}$

= $2.545

c)

Yes, the U.S. dollar is selling at a premium relative to the Canadian dollar.

This is because we are being told that the spot exchange rate for the Canadian dollar is Can $1.12 & in six (6) months time the forward rate will be Can $1.14.

d)

The U.S dollar is expected to appreciate in value because it is trading at a premium in the forward market.

e)

Canada has higher interest rates. This determined by using the formula:

= $\dfrac{(\dfrac{Fwd}{Spot }-1)}{n}$

where; n= numbers of years = 6 month/12 month = 0.5 year

Then;

$=\dfrac{(\dfrac{1.14}{1.12 }-1)}{0.5}$

$= \dfrac{(1.0178-1)}{0.5}$

$= \dfrac{(0.0178)}{0.5}$

= 0.0356

= 3.56%