Problem 20-12 Spot versus Forward Rates Suppose the spot and three-month forward

Question

Problem 20-12 Spot versus Forward Rates

Suppose the spot and three-month forward rates for the yen are ¥79.80 and ¥79.12, respectively.

What would you estimate is the difference between the annual inflation rates of the United States and Japan? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Suppose the spot and three-month forward rates for the yen are ¥79.80 and ¥79.12, respectively.

Explanation / Answer

First we need to find the differential between spot and three month forward rates,

= (forward rate - spot rate)/spot = 79.12-79.8/79.8 = -.008521 or -.85%

So approx inflation difference = (1+(-.0085))^4 - 1 = - 0.03356 or -3.35%

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