Suppose the spot exchange rate for the Canadian dollar is Can$1.15 and the six-m

Question

Suppose the spot exchange rate for the Canadian dollar is Can$1.15 and the six-month forward rate is Can$1.19

1-Assuming purchasing power parity (PPP) holds, what is the cost in the U.S. of a Moosehead beer if the price in Canada is Can$2.50?

2-: Identify two reasons why PPP or the "law of one price" may be violated or may not hold.
3-Is the Canadian dollar selling at a premium or a discount relative to the U.S. dollar in the forward market? Explain.

4-Explain which currency (U.S. dollar or Canadian dollar) is expected to appreciate in value.

Explanation / Answer

If PPP holds good means the price of a good in one country is equal to its price in another country after adjusting for the exchange rate between the two countries.

Spot exchange rate = Can$1.15

Price of Moosehead bee in Canada = Can$2.5

Price of Moosehead bee in U.S = Can$2.5 / Can$1.5 = $2.17

Price of Moosehead bee in U.S = $2.17

In Spot market you have to pay Can$1.15 for each dollar but in future it will results in payments of Can$1.19, for each dollar.

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