Question

Suppose the spot exchange rate for the Canadian dollar is Can$1.12 and the six-month forward rate is Can$1.14.

A. Which is worth more, a U.S. dollar or a Canadian dollar?
B. Assuming absolute PPP holds, what is the cost in the United States of an Elkhead beer if the price in Canada is Can$2.85?
C. Is the U.S. dollar selling at a premium or a discount relative to the Canadian dollar?D. Which currency is expected to appreciate in value?E. Which country do you think has higher interest rates - the United States or Canada?

Answer 1

Step-by-step explanation:

Given that:

a)

1$ = Can $1.12

It takes a value of 1 U.S dollar to have 1.12 Canadian dollars. This signifies that the U.S dollar is worth more than Canadian dollars.

b)

Assuming that the absolute Purchasing Power Parity PPP holds,

Since 1$ = Can $1.12, the cost in the United States of an Elkhead beer, if the price in Canada is Can$2.85 can be determined to be:

=
`(2.85)/(1.12)`

= $2.545

c)

Yes, the U.S. dollar is selling at a premium relative to the Canadian dollar.

This is because we are being told that the spot exchange rate for the Canadian dollar is Can $1.12 & in six (6) months time the forward rate will be Can $1.14.

d)

The U.S dollar is expected to appreciate in value because it is trading at a premium in the forward market.

e)

Canada has higher interest rates. This determined by using the formula:

=
`(((Fwd)/(Spot )-1))/(n)`

where; n= numbers of years = 6 month/12 month = 0.5 year

Then;

`=(((1.14)/(1.12 )-1))/(0.5)`

`= ((1.0178-1))/(0.5)`

`= ((0.0178))/(0.5)`

= 0.0356

= 3.56%