9. Suppose the nominal interest rate for 1-year borrowing and lending is 5% in t
ID: 1122451 • Letter: 9
Question
9. Suppose the nominal interest rate for 1-year borrowing and lending is 5% in the US, and 3.5% in Japan. Suppose, too, that the nominal yen/dollar exchange rate is currently ¥142/S and is expected to be ¥138/$ next year What is the expected rate of return on Japanese yen-denominated lending for an investor a. b. If you are in the market for short term borrowing, what currency should you borrow in? c. If you have money you want to lend (invest) in the short term, what currency should you d. How would an arbitrageur make money under these conditions (i.e. -What currency would starting with dollars? Explain. lend in? Explain. you borrow? What currency would you lend?)Explanation / Answer
a - the expected rate of return on Japanese yen dominated lending would be 1.75%
b - I would borrow US dollars in the market for short-term borrowing as it is more stable and used in payments all over the world.
c - I would invest in Japanese yen as it is the third most traded currency in the world and the most heavily traded currency in Asia. Due to its relatively low-interest rates, the Japanese Yen is often used in carrying trades with the Australian Dollar and the US Dollar.
d - I would borrow US dollars in the market for short-term borrowing as it is more stable and used in payments all over the world. I would invest in Japanese yen as it is the third most traded currency in the world and the most heavily traded currency in Asia. Due to its relatively low-interest rates, the Japanese Yen is often used in carrying trades with the Australian Dollar and the US Dollar.
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