3) (15 points) Consider a Canadian investor with 1,000 Canadian dollars to place in a...
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3) (15 points) Consider a Canadian investor with 1,000 Canadian dollars to place in a bank deposit in either Canada or France. The (one-year) interest rate on bank deposits is 1.25% in France and 1.75% in Canada. The (one-year) forward dollareuro exchange rate (F$/) is 1.6 dollars per euro and the euro-dollar spot rate (E/$) is 0.8 euros per dollar. Answer the following questions using the exact equations for UIP or CIP as necessary:
a) Compute the dollar-euro spot rate (E$/). (1 point)
b) What is the dollar-denominated return on Canadian deposits for this investor? (2 points)
c) What is the (riskless) dollar-denominated return on French deposits for this investor? (4
points)
d) Is there an arbitrage opportunity here? Is this an equilibrium in the forward exchange rate
market? Explain why or why not. (3 points)
e) Given that the dollar-euro spot rate is the one calculated in a), and interest rates are as stated
previously, what is the equilibrium forward rate, according to covered interest parity (CIP)? (5 points)
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