Question

The general relationship between spot and forward exchange rates is specified by a concept called interest rate parity. It specifies that investors should expect to earn same return in all countries after adjusting for risk. The relationship is expressed in the following equation: Both the forward and spot rates are expressed in terms of the amount of home currency received per unit of foreign currency. Your overall return will be higher than the investment's stated return if the currency in which your investment is denominated appreciates relative to your home currency. On the other hand, your overall return will be lower if the foreign currency you receive -Select-decreases in value. If this relationship doesn't hold, currency traders will buy and sell currencies engaging in arbitrage until the relationship does hold.Quantitative Problem: Assume that interest rate parity holds. In the spot market 1 Japanese yen = $0.005, while in the 180-day forward market 1 Japanese yen = $0.0052. 180-day risk-free securities yield 1.35% in Japan. What is the yield on 180-day risk-free securities in the United States? Round your answer to 2 decimal places. Do not round intermediate calculations. _____________%.

Answer 1

Answer: -2.55%

Explanation:

The formula to calculate Forward Rate is:

Forward Rate = Spot rate X $\frac{1 + I_{O} }{1 + I_{D} }$

where $I_{O}$ is the Interest rate of the overseas country and

$I_{D}$ is the Interest rate of the domestic country

$0.0052 = 0.005 X  $\frac{1 + 0.0135 }{1 + I_{D} }$

$0.0052 X ${1 + I_{D} }$ =  0.005 X  1.0135

$0.0052 X ${1 + I_{D} }$ =  0.0050675

${1 + I_{D} }$ =  $\frac{0.0050675}{0.0052}$

${1 + I_{D} }$ =  0.9745 - 1

${I_{D} }$ =  - 0.02548  

The yield on 180-day risk-free securities in the United States is -2.55%