Question

4. Interest rate parity Aa Aa E The rise of globalization is due to the many companies that have become multinational corporations for various reasons-for example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence exposes companies to different kinds of risk as well--for example, political risk and exchange rate risk. The relationship between interest rates and exchange rates can be represented through the concept of interest rate parity. Consider the following: An American investor is considering investing $1,000 in default-free 90-day Japanese bonds that promise a 3% annual nominal return. • The spot exchange rate is 102.19 per dollar. • The 90-day forward exchange rate is X100.66 per dollar. The investor's annualized return on these bonds-if he or she can lock in the dollar return by selling the foreign currency in the forward market-will be

Answer 1

Dollor return will be 9%. Calculation is below

Dollor	1000.00
Conversion rate Yen/Dollor	102.19
Investment in Yen	102190.00
Rate of Int (360 days a year)	3% PA
return for 90 days in Yen	766.43
Total amount after 90 days	102956.43
Forward rate 100.66 Yen/Dollor	100.66
Dollor amount	1022.81
Return for 90 days in Dollor	22.81
Rate of Return PA	9%