The year riskfree interest rate of investments in US dollars is The year risk
free interest rate of investments in Canadian dollars is The current spot exchange
rate between the two currencies is : the price of USD is CAD. The year forward price
of USD is CAD. You can trade in year riskfree discount bonds denominated in both US and
Canadian dollars in the forward contract to buy USD year from now, and in the spot foreign
exchange market, where you can buy and sell USD.
Consider the following strategy:
Borrow USD at today, which means that the total loan repayment obligation after a
year would be USD.
Convert USD into CAD at the spot rate of
Lock in the rate on the deposit amount of CAD, and simultaneously enter into a
forward contract that converts the full maturity amount of the deposit into USD at the one
year forward rate of USD CAD.
After one year, settle the forward contract at the contracted rate of Suppose the
above arbitrage strategy generates USD today and nothing otherwise, please solve for
and
