Today in the spot market $1 = 1.82 Swiss francs and $1 = 130 Japanese yen.In the 90-day forward market,$1 = 1.84 Swiss francs and $1 = 127 Japanese yen.Assume that interest rate parity holds worldwide.Which of the following statements is most CORRECT?
A) Interest rates on 90-day risk-free U.S.securities are higher than the interest rates on 90-day risk-free Swiss securities.
B) Interest rates on 90-day risk-free U.S.securities are higher than the interest rates on 90-day risk-free Japanese securities.
C) Interest rates on 90-day risk-free U.S.securities equal the interest rates on 90-day risk-free Japanese securities.
D) Since interest rate parity holds interest rates should be the same in all three countries.
E) Interest rates on 90-day risk-free U.S.securities equal the interest rates on 90-day risk-free Swiss securities.

Question

Quizplus · Accepted Answer

The easiest way to do this is to make an example up.Assume the annual interest rate in the U.S.is 16%.Suppose in the U.S.you start off with $1.00,so after 90 days you will have $1.00 11ea856c_8afe_38da_9aec_2787f1c8ca8a_TB1222_11 (1 + 0.16/4)= $1.04.In Switzerland,you will start with 1.00 11ea856c_8afe_5feb_9aec_4d0e72aa1226_TB1222_11 1.82 = SF 1.82 and end up with 1.04 11ea856c_8afe_5fec_9aec_bbcd97e54bd6_TB1222_11 1.84 = SF 1.9136.The return in Switzerland is 1.9136/1.82 - 1 = 5.14%.(This is higher than the 4% U.S.rate. )In Japan,you will start with 1.00 11ea856c_8afe_5fed_9aec_29ef93092104_TB1222_11 130 = 130 yen and end up with 1.04 11ea856c_8afe_86fe_9aec_7ba064056876_TB1222_11 127 = 132.08 yen.The return is 132.08/130 - 1 = 1.6%.(This is lower than the 4% U.S.rate. )

Today in the Spot Market $1 = 1