Suppose the current spot rate price of the Canadian $ (C$) in terms of US $ ($) is 1.2 C$/$. Suppose you are deciding between $10,000 worth of either Canadian bonds that earn 2.2% or US bonds that earn 3.1%.
a. In order for covered interest parity to hold, what would the 1-year forward exchange rate have to be? Is the $ selling at a forward premium or discount?
b. If you invest in the Canadian bonds, how many C$ do you need today? At the end of the year, how many C$ would you have to change back into US $ (principle plus interest)?
c. If you enter into a forward contract, at the rate calculated in “a”, how many US $ would you have?
d. If you invested in the US bonds, at the end of the year, how many $ would you have (principle plus interest)?
e. If your answer to “c” and “d” were not virtually the same, explain how you could gain “risklessly.”