Problem 1 : Derek Tosh and Yen-Dollar Parity
Derek Tosh is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat ¥89.00/$, while the 360-day forward rate is ¥84.90/$. Forecast inflation is 1.100% for Japan, and 5.900% for the US. The 360-day euro-yen deposit rate is 4.700%, and the 360-day euro-dollar deposit rate is 9.500%.
a. Diagram and calculate whether international parity conditions hold between Japan and the United States.
b. Find the forecasted change in the Japanese yes/U.S. dollar (¥/$) exchange rate one year from now.
Assumptions Value
Forecast annual rate of inflation for Japan 1.100%
Forecast annual rate of inflation for United States 5.900%
One-year interest rate for Japan 4.700%
One-year interest rate for United States 9.500%
Spot exchange rate (¥/$) 89.00
One-year forward exchange rate (¥/$) 84.90
Problem 2 : Takeshi Kamada -- CIA Japan (A)
Takeshi Kamada, a foreign exchange trader at Credit Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to invest $5,000,000 or its yen equivalent, in a covered interest arbitrage between U.S. dollars and Japanese yen. He faced the following exchange rate and interest rate quotes.
| Assumptions |
|
Value |
| Arbitrage funds available |
|
|
$5,000,000 |
| Spot rate (¥/$) |
|
|
|
118.60 |
| 180-day forward rate (¥/$) |
|
|
117.80 |
| 180-day U.S. dollar interest rate |
|
4.800% |
| 180-day Japanese yen interest rate |
|
3.400% |
Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or expected change in the spot rate for UIA, invest in the higher interest yielding currency.
If the difference in interest rates is less than the forward premium (or expected change in the spot rate), invest in the lower yielding currency.