Question

The CFO of Honda Motors Japan observes that USD/JPY spot rate has been holding steady, and the interest rates in both currencies have also been relatively fixed over the last week. The company has 10 Billion Yen in cash that the CFO does not expect using in the next 6 months. The CFO is wondering if he should keep the cash in dollars or yen. Essentially he is wondering if there is a benefit in doing an uncovered interest rate arbitrage between JPY and USD. The information he observes is as follows:

• Spot interest rate is 115 ¥/$

• USD 6 month LIBOR rate is 2.47%

• JPY 6 months LIBOR rate is 0.019%

The investment bank advising him suggests that JPY/USD should hold steady at 115 over the next 6 months. In which currency should he keep his money and what will be his profit by doing so? How much will his profit be by choosing the currency that earns him higher returns?

Answer 1

Spot rate will be same for 6 months.

10 billion yen will yield interest of 0.019%

10,000,000,000 × 0.019% = 1,900,000 yen

Now 10 billion yen in dollars

10,000,000,000 ÷ 115 = $ 86956521.74

Interest on $ 86,956,521.74 will be 2.47%

Interest yield = 2.47% of $86,956,521.74 = $2,147,826

Now both interest will be compared in terms of dollars.

$2,147,826 and 1,900,000 / 115 = $16,521.74

Currency will dollars will yield more interest and will be more profitable.

Hence, Currency should be kept in dollars. That is 10 billion yen as $ 86,956,521.74 in bank to have interest that is $ 2,147,826 which will be more profitable as compare to 10 billion yen.

If dollars will be kept profits will be $ 2,147,826.

​​​​​​Above is amount of profit that will earn higher profits.