Question

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?

Answer 1

Answer:

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.