1. Suppose today’s exchange rate is $USD 0.90/CAD. The annualized six-month interest rates on US dollars and Canadian dollars are 2% and 5% respectively. The six-month forward rate is $USD 0.89/CAD. A foreign exchange advisory service has predicted that the CAD will appreciate to $USD 0.93/CAD within six months.
Does covered interest rate parity hold? What kind of forward contract should be used? What is the arbitrage profit per $100,000 USD?
A) Yes; none; arbitrage profit= $0
B) No, short forward on CAD; arbitrage profit= $361
C) No, short forward on CAD; arbitrage profit= $1833
D) No, long forward on CAD; arbitrage profit= $1833
2. Suppose today’s exchange rate is $USD 0.90/CAD. The annualized six-month interest rates on US dollars and Canadian dollars are 2% and 5% respectively. The six-month forward rate is $USD 0.89/CAD. A foreign exchange advisory service has predicted that the CAD will appreciate to $USD 0.93/CAD within six months.
What action do you need to take to speculate in the forward market? What is the expected profit for CAD100,000?
A) short forward on CAD; expected profit= $361
B) long forward on CAD; expected profit= $4,000
C) short forward on USD; expected profit= $1,000
D) long forward on USD; expected profit= $4,000