Question

Assume that interest rate parity holds. In the spot market 1 Japanese yen = $0.00905, while in the 90-day forward market 1 Japanese yen = $0.00913. In Japan, 90-day risk-free securities yield 1%. What is the yield on 90-day risk-free securities in the United States? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Ans. We buy 1 Japanese Yen at the rate of $0.00905 in the Japanese market. The 90-day risk-free rate r in Japanese market = 1%. Since this rate is annual so we need to find an equivalent rate for 90 days which is = 1% x 90/360 = 0.25%

Hence if we invest 1 Japanese Yen in the bank we will get 0.25% interest on our amount after 90 days. So the amount we get after 90 days will be = 1 x (1.0025) = 1.0025 Japanese Yen.

If we sell this Japanese Yen in US market to get dollars. we will get = 1.0025 x 0.00913 =  0.009152825

In Spot market we have $0.00905 and in Future market we will have $0.00915285

Yield in US market = (Future value - Spot Value)/Spot Value = (0.00915285-.00905)/0.00905 = 1.14%

hence the yield in US Market = 1.14%

Further annual return will be 1.14% x 4= 4.54%