In 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 yen-dollar exchange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market.
E) The relationship between spot and forward interest rates cannot be inferred.

Question

Quizplus · Accepted Answer

Interest rate parity implies that the difference in interest rates between two countries is equal to the difference between the forward exchange rate and the spot exchange rate, adjusted for the time period. Since both Japan and the US have the same 90-day securities annualized return of 4%, there would be no incentive to move funds between the two for arbitrage, implying that the spot and 90-day forward exchange rates should be equal.

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