Suppose the Japanese yen spot exchange rate is 118 yen = $1.00. Assume that U.S.

Question

Suppose the Japanese yen spot exchange rate is 118 yen = $1.00.

Assume that U.S. six-month Treasury bills have an annualized rate of 6.2% while default-free Japanese bonds that mature in six months have an annualized rate of 5.0% and that interest rate parity holds. Find the six-month forward exchange rate in terms of dollars per yen.

1 Yen = .00468 dollars

Hint: First, convert annual rates to six month rates e.g. (1 + rh) = (1 + 0.062/2) and (1 + rf) = (1 + 0.05/2). Then find the spot exchange rate in terms of dollars per yen; you can use the equation on p.599 to solve this question. Check figure: The spot rate in terms of $/Yen is $0.008475/Yen.

Explanation / Answer

The answer is as follows:

Semi annual rates:

US Treasury Bills = (1+0.062/2) = 1.031

Japanese bonds = (1+0.05/2) = 1.025

Forward rate = Spot rate * Interest on Japanese bonds / Interest on US treasury bills

                   = (1/118) * 1.025/1.031

                   = 0.0084745 * 0.99418

                   = 0.008425258

Therefore, the forward rate, 1 Yen = 0.008425 US $.

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