International Financial Management 2nd Edition by Geert Bekaert ,Robert Hodrick

Exercise 11

One of your colleagues at Deutsche Bank thinks that the dollar is severely undervalued relative to the yen. He has calculated that the PPP exchange rate is ¥140/$, whereas the current exchange rate is ¥105/$. Because interest rates are 3% p.a. lower in Japan than in the United States, he thinks that this is a good time to speculate by borrowing yen and lending dollars. What do you think