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Question:

# Suppose that the exchange rate between the Canadian dollar and the Brazilian real is BRL/CAD = 3.27. If the interest rate in Canada is 2.5 percent and the interest rate in Brazil is 8.0 percent, the exchange rate you should expect one year from today is closest to:

explanation

To understand the Fisher relationship that links interest rates and forward exchange rates, recognize that an investment in the Canadian dollar should convert to the same number of Brazilian reais (the plural of real), as one would obtain by converting the dollar to reais and investing it in Brazil. That is 1 x 1.025 F = 3.27 x 1.08, where F is the future exchange rate between the Canadian dollar and the real.
Solving for the future rate, F = 3.27 x (1.08/1.025) = BRL 3.45/CAD
CFA Level 1, Volume 2, Study Session 5, Reading 20 – Currency Exchange Rates, LOS 20f: Explain the arbitrage relationship between spot rates, forward rates, and interest rates