In June 2006, a Brazilian investor is considering investing in bank deposits in Brazil and Canada. The annual interest rate on Brazilian deposits is 6.25%, versus 3.75% on deposits in Canada. Suppose that the forward rate in June 2006 is equal to Reales/CAD = 8.2. In June 2006, the expected exchange rate for delivery in Jun 2007 is 8.25 Reales/CAD. For the remainder of this question, please use the linear approximations for uncovered and covered interest rate parity. The spot exchange rate in June 2006 is Reales/CAD=8.

a)Does covered interest parity hold in this example? If so, how do you know? [2 points]

b)Does uncovered interest parity hold in this example? If so, how do you know? If not, what is the implied risk premium? Which deposits pay a higher expected return?

c)Suppose the exchange rate in June 2007 is equal to 8.528 reales per Canadian dollar. Calculate the Brazilian investors actual return, assuming that he invests in Canadian deposits in June 2006. How do these answers compare with those from (b)?