5. If the spot rate for Canadian dollars is 1.25 dollars equals 1 US $, and the

Question

5. If the spot rate for Canadian dollars is 1.25 dollars equals 1 US $, and the annual interest rate on fixed rate one-year deposits of Canadian dollars is 2.5% and for US$ is 1.5%, what is the nine-month forward rate for one US dollar in terms of Canadian dollars? Assuming the same interest rates, what is the 18-month forward rate for one Canadian dollar in US dollars? Is this an indirect or a direct rate? If the forward rate is an accurate predictor of exchange rates, in this case will the Canadian Dollar get stronger or weaker compared to the US dollar? What does this indicate about the market’s inflation expectations in Canada compared to the US? On January 2d, 2017, Toyota expects to ship 25,000 Lexus SUVs from its plant in Canada to the US, which it will sell through US dealers on 270-day terms at $38,000 each. So Toyota will receive a US$ payment from its dealers on

Explanation / Answer

We will use covered interest parity. the formula is

Forward Rate in one year = Spot x (1+domestic interest rate)/(1+foreign interest rate)

Spot rate = 1.25

Interest rate in domestic country = 2.5% per annum

Interest rate in foreign country = 1.5% annum

Number of days in year = 360

Number of days in nine months = 270

Putting values in the formula

Forward rate = 1.25 x ( 1+ 2.5% x 270/360) / (1+1.5% x 270/360)

Forward rate = 1.25 x (0.76875/0.76125)

Forward rate = 1.25 x 1.009852

Forward rate = 1.26 Canadian dollars

2 ) in this case we have to calculate 1 canadian dollar will be how many US dollar . it is calculated below

1.25 CAD = $1 us

1 cad = 1/1.25 = 0.80 dollar

the formula is

Forward Rate in one year = Spot x (1+domestic interest rate)/(1+foreign interest rate)

Spot rate = 0.80

Interest rate in domestic country = 1.5% per annum

Interest rate in foreign country = 2.5% annum

Number of days in 18 months = 540

Number of days in 18 months = 540

Putting values in the formula

Putting values in the formula

Forward rate = 0.80 x ( 1+ 1.5 % x 540/360) / (1+2.5% x 540/360)

Forward rate = 0.80 x (1.5225 /1.5375)

Forward rate = 0.80 x 0.990244

Forward rate = 0.79 us dollars

Exchange rates are quoted in terms of how many foreign currencies does USD 1 buy, These are called 'direct rates'. In this case will indirect rate

4) This is a case where 1 Canadian dollar has become weakening as earlier it required to purchase at $ 0.80 now it has spend $ 0.79 after 18 months means the US currency has strengthen

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