Use the information below to answer the following questions. Currency per U.S. $
ID: 2729962 • Letter: U
Question
Use the information below to answer the following questions. Currency per U.S. $ Australia dollar 1.2372 6-months forward 1.2361 Japan Yen 100.2800 6-months forward 100.1000 U.K. Pound .6797 6-months forward .6776 Suppose interest rate parity holds, and the current risk-free rate in the United States is 4 percent per six months. Use the approximate interest rate parity equation to answer the following questions. Requirement 1: What must the six-month risk-free rate be in Australia? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Risk-free rate % Requirement 2: What must the six-month risk-free rate be in Japan? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Risk-free rate % Requirement 3: What must the six-month risk-free rate be in Great Britain? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Risk-free rate %
Explanation / Answer
Requirement 1:
Six Month Risk Free Rate in Australia:
Interest Rates:
US = 4% and Australia = x%
1US $ = 1.2372 Australian $
1 US $ (1.04) = 1.2372 Australian $ (1+x)
1 US $ = 1.2372 / 1.04 (1+x) Australian $
6 month forward rate is 1 US $ = 1.2361 Australian $
As Interest Rate Parity holds,
1.2372 (1+x) / 1.04 = 1.2361
1+x = 1.03907
x = 0.0391
Six Month Risk Free Rate in Australia = 3.91%
Requirement 3:
Six Month Risk Free Rate in Great Britain:
Interest Rates:
US = 4% and Great Britain= x%
1US $ = 0.6797 UK Pound
1 US $ (1.04) = 0.6797 UK Pound (1+x)
1 US $ = 0.6797 / 1.04 (1+x) UK Pound
6 month forward rate is 1 US $ = 0.6776 UK Pound
As Interest Rate Parity holds,
0.6797 (1+x) / 1.04 = 0.6776
1+x = 1.0368
x = 0.0368
Six Month Risk Free Rate in Great Britain = 3.68%
Note: For the purpose of Requirement 2, Japan rate is not understandable.
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