If the spot exchange rate is 110 yen per U.S.dollar,the "fair" forward exchange rate is 115 yen per U.S.dollar,and the risk-free borrowing rate in the United States is 2.5%,what must the risk-free borrowing rate be in Japan?

Question

Quizplus · Accepted Answer

The correct answer can be found using the Interest Rate Parity (IRP) formula, which states that the difference in the national interest rates for financial securities of similar risk and maturities should be equal to the forward rate discount or premium for foreign exchange. Given the spot rate (S) is 110 yen/USD, the forward rate (F) is 115 yen/USD, and the US risk-free rate (r_d) is 2.5%, we can solve for the Japanese risk-free rate (r_f) using the formula: F/S = (1 + r_d)/(1 + r_f). Rearranging and solving for r_f gives us approximately 7.2%.

If the Spot Exchange Rate Is 110 Yen Per U