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?

Question

Quizplus · Accepted Answer

According to interest rate parity, the difference in interest rates between two countries should be equal to the percentage difference between the forward exchange rate and the spot exchange rate.
Given that the 90-day securities in Japan and the US have the same interest rates, their forward exchange rates should be the same. Therefore, the yen-dollar spot exchange rate must equal the yen-dollar exchange rate in the 90-day forward market. 
Since the forward exchange rate is based on the interest rate differential between the two countries, the yen-dollar exchange rate in the 180-day forward market should be higher than the 90-day forward market because the interest rate in the US is higher for longer-term securities. Therefore, choices A, B, C, and D are incorrect.

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