Question

1. A HIGHER/ LOWER OR SAME

Multinational Financial Management: Interest Rate Parity 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 (-Select- return in all countries after adjusting for risk. The relationship is expressed in the following equation: Forward exchange rate – 1+th Spot exchange rate 1+rf 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 (-Select- relative to your home currency. On the other hand, your overall return will be lower if the foreign currency you receive-Select- in value. If this relationship doesn't hold, currency traders will buy and sell currencies engaging in ( -Select- until the relationship does hold. Quantitative Problem: Assume that interest rate parity holds. In the spot market 1 Japanese yen = $0.013, while in the 180-day forward market 1 Japanese yen = $0.0135. 180-day risk-free securities yield 1.5% 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. %

2. DECREASES. APPRECIATES

3. DECREASES. APPRECIATES

4.

Answer 1

Interest Rate parity:

Forward exchange rate/Spot exchange rate = [1+ rq/1+rb]^n

Where Rq= rate of quoted currency i.e Dollars

                Rb= rate of base currency i.e Yen

$0.0135/$0.013=[1+rq/1+1.5%]^0.5

Rq=9.445%

Therefore, the yield on 180 day risk free securities in the United States is 9.45%