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Use the asset approach to exchange rate determination discussed in class to answer the following questions. The interest rate on US dollar denominated assets maturing
Use the asset approach to exchange rate determination discussed in class to answer the following questions. The interest rate on US dollar denominated assets maturing in one year is 10% and the interest rate on comparable Canadian dollar denominated assets is 8%. Consider two possible expectations for the direct spot exchange rate between the Canadian dollar and the U.S. dollar (Canadian dollars per one U.S. dollar (EcsUss) ) in one year: (1) the spot rate will fall by 5 Canadian cents or (2) the spot rate will rise by 3 Canadian cents (note that these changes are in absolute levels, not in percentage terms). Explain which expectation for the future spot rate makes sense. Determine the current equilibrium spot rate under each scenario to justify your answer. Suppose interest rates are as given initially (10\% and 8% ) and the current spot rate equals 2 Canadian dollars per U.S. dollar. Calculate the forward discount or forward premium
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