In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?
A) the yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
B) the yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
C) the spot rate equals the 90-day forward rate.
D) the spot rate equals the 180-day forward rate.
E) the yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.

Question

Quizplus · Accepted Answer

Interest rate parity implies that the forward exchange rate should reflect the interest rate differential between two countries. Since the 90-day securities have the same return in both countries, the spot rate should equal the 90-day forward rate.

In Japan, 90-Day Securities Have a 4% Annualized Return and 180-Day