ONLINEEXAM INSTRUCTIONS
•Type your answers in an MS Word or Excel file where possible.
•The total word limit for this paper is: 3000. Examiners will not continue marking past this limit.
•Only one file can be submitted for each exam– please include all your answers in one file.
Page 2Question 1(a)Suppose a Canadian investor has CAD 1 million to invest for 90 days. The current spot rate between CAD and USD is that 1 USD = 1.1239 CAD. He is considering two options:Option 1: He can invest this money in a local bank in Toronto, and earn annualized return of 0.75%. Option 2: Alternatively, he could sell his Canadian dollars for US dollars and place a USD deposit in Chicago and earn 0.4% annualized return.
(i)Assuming that the borrowing and lending rate is the same within each country,what is theoretical 90-day forward rate between Canadian dollar and US dollar that makes the investor indifferent between the two options (ignoring transaction costs and taxes)? Define covered interest parity. You may use a diagram to assist your answer.[40%]
(ii)Assuming the actual 90-day forward rate is 1.1200.
Explain how the investor could make a profit without risk and without investing any of his own money (ignoring transaction costs and taxes).[30%](b)In Germany, financial institutions hold significant equity interests in the borrowing firms. How does this affect the cost of financial distress and bankruptcy?
