suppose the quarterly (90-day) interest rate in the us is 2.5% and it is 4% in canada. if the $/cd spot exchange rate is $0.80/cd and the 90-day forward exchange rate between us and canadian dollars is $0.79/cd, does the interest rate parity (irp) hold? why or why not? if it does not hold, what is the direction of the capital flow?

Question

Reagan Huffman

Business

26 November, 08:16

suppose the quarterly (90-day) interest rate in the us is 2.5% and it is 4% in canada. if the $/cd spot exchange rate is $0.80/cd and the 90-day forward exchange rate between us and canadian dollars is $0.79/cd, does the interest rate parity (irp) hold? why or why not? if it does not hold, what is the direction of the capital flow?

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Jazlyn Blair · Answer 1

interest rate parity

(0.8/1) * (1.4*3/12) / (1.25*3/12) = 0.8

Hence It is proved that interest rate parity does not hold because the vale of forward contract is $0.79/CD.