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Interest rates in the United States are 1% and in Canada they are currently at 2%....

Interest rates in the United States are 1% and in Canada they are currently at 2%. The USD/CAD spot rate is 0.9881. You are offered a 12-month forward rate of 1.01.

• Calculate the theoretical forward rate implied by Interest Rate Parity.

• Is the forward contract relatively under-valued or overvalued?

• What is the percentage return from engaging in Covered Interest Arbitrage? (Calculate as a percentage of your initial borrowing, accurate to 4 decimal places)

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Answer #1

1) Theoretical forward rate is US $ 0.9784/ Canada $

2) The forward contract is relatively overvalued.

3) Percentage of the return for covered interest arbitrage is 0.7941%

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