Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return.In the United States, 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 of the following statements is most CORRECT?
A)The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.
B)The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
C)The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
D)The spot rate equals the 90-day forward rate.
E)The spot rate equals the 180-day forward rate.

Question

Quizplus · Accepted Answer

According to interest rate parity, the difference in interest rates between two countries should be equal to the percentage difference in the forward exchange rate between the two currencies. In this case, both the US and Japan have a 4% annualized return on 90-day securities, so there should be no difference in the yen-dollar exchange rate in the 90-day forward market. Therefore, the yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. This is the only choice that is consistent with interest rate parity.

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