Assume the spot rate for the Japanese yen currently is ¥106.83 per dollar while the one-year forward rate is ¥107.20.Also assume a risk-free asset in Japan is currently earning 4.6 percent.If interest rate parity holds,approximately what rate can you earn on a one-year risk-free U.S.security?

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Quizplus · Accepted Answer

The interest rate parity (IRP) formula relates the spot exchange rate, the forward exchange rate, the domestic interest rate, and the foreign interest rate. According to IRP, the return on a domestic risk-free asset should equal the return on a foreign risk-free asset, adjusted for the change in exchange rates. The formula for IRP is: (1 + i_d) = (F/S) * (1 + i_f), where i_d is the domestic interest rate, i_f is the foreign interest rate, F is the forward exchange rate, and S is the spot exchange rate. Rearranging to solve for i_d gives: i_d = (F/S) * (1 + i_f) - 1. Plugging in the given values: i_d = (107.20/106.83) * (1 + 0.046) - 1 ≈ 0.0424 or 4.24%.

Assume the Spot Rate for the Japanese Yen Currently Is