CFA Level I · CFA Level I Exam · Capital Flows and the FX Market
The spot USD/CAD rate is 1.3500 (CAD per USD). The 1-year interest rate is 2.0% in USD and 4.0% in CAD. Using covered interest rate parity with annual compounding, the 1-year forward USD/CAD rate is closest to:
The forward rate is about 1.3765. Under covered interest rate parity, the forward equals spot times the price-currency rate factor over the base-currency rate factor: 1.35 x 1.04/1.02. CAD has the higher interest rate, so it trades at a forward discount.
- A1.3235
- B1.3500
- C1.3765Correct
Explanation
The forward rate is spot x (1 + i_price)/(1 + i_base), where CAD is the price currency and USD is the base. 1.3500 x 1.04/1.02 = 1.3765. Answer A inverts the interest rate ratio, which would be wrong because the higher-rate price currency must depreciate forward.
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