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Question 5 (20 marks) a. Assume the current spot rate is C$1.1875 and the one-year forward rate is C$1.1724. The nominal risk-free rate in Canada
Question 5 (20 marks) a. Assume the current spot rate is C$1.1875 and the one-year forward rate is C$1.1724. The nominal risk-free rate in Canada is 4 percent while it is 3 percent in the U.S. Using covered interest arbitrage, how much can you earn as an extra profit over that which you would earn if you invested $1 in the U.S. (8 marks) b. You are considering invest in a riskless project in Canada. The project has an initial cost of C$1.5 million and is expected to produce cash inflows of C$600,000 a year for 3 years. The project will be worthless after the first 3 years. The expected inflation rate in Canada is 4 percent while it is 3.6 percent in the U.S. A risk-free security is paying 5.8 percent in the U.S. The current spot rate is C$1=$0.8276. Assume the international Fisher effect applies. What is the net present value of this project in US dollars using the foreign currency approach? (12 marks)
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