Suppose in the spot market 1 U.S. dollar equals 1.60 Canadian dollars. 6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%). 6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?

Answer

1 U.S. dollar = 0.6235 Canadian dollars
1 U.S. dollar = 0.6265 Canadian dollars
1 U.S. dollar = 1.0000 Canadian dollars
1 U.S. dollar = 1.5961 Canadian dollars
1 U.S. dollar = 1.6039 Canadian dollars