Answer: 1.91%

## Explanation To solve this problem, we need to use two key formulas: ### 1. Real Interest Rate Formula \[ R_{\text{real}} = \frac{1 + R_{\text{nom}}}{1 + R_{\text{infl}}} - 1 \] ### 2. Covered Interest Parity Formula \[ F = S \cdot \frac{(1 + R_{\text{CAD}})^t}{(1 + R_{\text{USD}})^t} \] **Given:** - Spot rate (S) = CAD 1.21 per USD 1 - Forward rate (F) = CAD 1.19 per USD 1 - US risk-free rate (R_USD) = 0.85% = 0.0085 - US inflation (R_infl, USD) = 2.50% = 0.025 - Canada inflation (R_infl, CAD) = 2.80% = 0.028 **Step 1: Calculate Canadian nominal interest rate using CIP** \[ (1 + R_{\text{CAD}})^1 = F \cdot \frac{(1 + R_{\text{USD}})}{S} \] \[ (1 + R_{\text{CAD}}) = 1.19 \cdot \frac{(1 + 0.0085)}{1.21} \] \[ (1 + R_{\text{CAD}}) = 1.19 \cdot \frac{1.0085}{1.21} \] \[ (1 + R_{\text{CAD}}) = 1.19 \cdot 0.8339 \] \[ (1 + R_{\text{CAD}}) = 0.9918 \] \[ R_{\text{CAD}} = 0.9918 - 1 = -0.00817 = -0.817\% \] **Step 2: Calculate real interest rates** **US Real Interest Rate:** \[ R_{\text{USD, real}} = \frac{1 + 0.0085}{1 + 0.025} - 1 \] \[ R_{\text{USD, real}} = \frac{1.0085}{1.025} - 1 \] \[ R_{\text{USD, real}} = 0.9839 - 1 = -0.0161 = -1.61\% \] **Canada Real Interest Rate:** \[ R_{\text{CAD, real}} = \frac{1 + (-0.00817)}{1 + 0.028} - 1 \] \[ R_{\text{CAD, real}} = \frac{0.99183}{1.028} - 1 \] \[ R_{\text{CAD, real}} = 0.9648 - 1 = -0.0352 = -3.52\% \] **Step 3: Calculate the difference** \[ \text{Difference} = |R_{\text{USD, real}} - R_{\text{CAD, real}}| \] \[ \text{Difference} = |-1.61\% - (-3.52\%)| \] \[ \text{Difference} = |1.91\%| = 1.91\% \] Therefore, the best estimate of the difference between the real interest rates in Canada and the US is **1.91%**.

Author: LeetQuiz .