The current spot rate is C$1.379 and the one-year forward rate is C$1.319. The n

Question

The current spot rate is C$1.379 and the one-year forward rate is C$1.319. The nominal risk-free rate in Canada is 4 percent while it is 8 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

$0.0780

$0.0473

$0.0073

$0.0853

$0.0000

The current spot rate is C$1.379 and the one-year forward rate is C$1.319. The nominal risk-free rate in Canada is 4 percent while it is 8 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

Explanation / Answer

The extra profit that can be earned by investing in Canada is $ 0.0073.

The calculations are shown below:

If invested in US the year end value of the investment will be = 1 * 1.08 = $1.08

If invested in Canada and brought back, the year end value of the investment will be $ 1.0873 as shown below:

!$ converted to C$ at the beginning of the year = 1*1.379 = C$ 1.379 (Simultaneously book forward at C$ 1.319

Value at the year end with 4% interest = 1.379 * 1.04 =1.43416 C$

Year end vlue converted to $ = 1.43416/1.319 = $1.0873

Therefore extra profit made by investing in Canada = 1.0873 - 1.08 = $ 0.0073

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