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The one-year interest rate in the U.S. is 3%, and the one-year rate in Japan is 5%. Investors expect the spot market exchange rate one year from now to be ¥100 = $1.
-A Japanese investor requires a 2% risk premium on US investments. She will acquire US assets if,on the current spot market,$1 can be exchanged for

Question

Quizplus · Accepted Answer

To determine if the Japanese investor will acquire US assets, we calculate the effective return of investing in the US, including the exchange rate change and the risk premium. The US interest rate is 3%, and the Japanese investor requires a 2% risk premium, making the total required return 5% (matching the domestic rate in Japan). The expected exchange rate is ¥100 = $1 in a year. If the current exchange rate allows for a return greater than or equal to this 5% (including the risk premium), the investor will find the investment attractive. The calculation involves finding the current exchange rate that would yield a 5% return considering the expected future exchange rate and the interest rate difference. Since the option that corresponds to an effective return meeting or exceeding the investor's requirement is "less than ¥96.19," it implies that for the investment to be attractive, $1 should exchange for less than ¥96.19 currently, factoring in the expected depreciation of the dollar against the yen and the required total return.

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