Assume that U.S. interest rate for the next three years is 5%, 6%, and 7% respectively. Also assume that Canadian interest rates for the next three years are 3%, 6%, 9%. The current Canadian spot rate is $.840. What is the approximate three-year forecast of Canadian dollar spot rate if the three-year forward rate is used as a forecast?
A) $.840
B) $.890
C) $.856
D) $.854

Question

Quizplus · Accepted Answer

The three-year forward rate is the rate at which two currencies can be exchanged in three years. Using interest rate parity, the forward rate can be calculated as follows:

(1+.09)^3 = (1+.07)(1+forward rate)
Forward Rate = 8.56%

Since the forward rate is higher than the current spot rate of $.840, it is expected that the Canadian dollar will appreciate against the U.S. dollar over the next three years. Therefore, the answer is C, $.856.

Assume That U