Question

Assume that interest rate parity holds. In the spot market 1 Japanese yen = $0.006, while in the 180-day forward market 1 Japanese yen = $0.0067. 180-day risk-free securities yield 1.45% in Japan. What is the yield on 180-day risk-free securities in the United States? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Solution:

As per the Interest rate Parity model

Exchange rate differential = Interest rate differential

( Forward Rate / Spot Rate ) = [ ( 1 + Risk free securities yield in Currency A ) / ( 1 + Risk free securities yield in Currency B ) ]

As per the Information given in the question we have

Spot rate 1 Japanese Yen = $ 0.006

Thus we have Spot rate as $ / ¥ = ( A/ B ) = $ 0.006

180 days Forward rate 1 Japanese Yen = $ 0.0067

Thus we have 180 day Forward rate as $ / ¥ = ( A /B ) = $ 0.0067

180 days Risk free securities yield in Japan = 1.45 % = 0.0145

180 days Risk free securities yield in United States = To find = x

Applying the above information in the equation we have

( 0.0067 / 0.006 ) = ( 1 + x ) / ( 1 + 0.0145 )

1.116667 = ( 1 + x ) / 1.0145

( 1 + x ) = 1.116667 * 1.0145

( 1 + x ) = 1.132858                  

x = 1.132858 – 1 = 0.132858

x = 13.2858 %

x = 13.29 % ( when rounded off to two decimal places )

Thus the 180 days United States Risk free securities yield is = 13.29 %