Suppose that you are the treasurer of IBM with an extra U.S. $1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810% (that's a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. What must the interest rate in Japan (on an investment of comparable risk) be before you are willing to consider investing there for six months?

Question

Quizplus · Accepted Answer

The correct answer is A because the interest rate in Japan must be higher than the interest rate in the US in order to make it worthwhile to invest there. The interest rate in the US is 1.810%, so the interest rate in Japan must be higher than 1.810%. The forward rate is $1.00 = ¥110, which means that the yen is expected to appreciate against the dollar over the next six months. This means that the investor will receive more yen for each dollar invested in Japan, which will offset the lower interest rate. The interest rate in Japan must be 11.991% in order to make it worthwhile to invest there.

Suppose That You Are the Treasurer of IBM with an Extra