In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In Canada, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which statement about the exchange rate is true?

Question

Quizplus · Accepted Answer

Interest rate parity implies that the forward exchange rate equals the spot exchange rate multiplied by the ratio of the domestic interest rate to the foreign interest rate. In this case, the 90-day forward exchange rate should be equal to the spot exchange rate multiplied by 1.0, and the 180-day forward exchange rate should be equal to the spot exchange rate multiplied by 1.1111. Therefore, the yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.

In Japan, 90-Day Securities Have a 4% Annualized Return and 180-Day