   Chapter 17, Problem 10P

Chapter
Section
Textbook Problem

INTEREST RATE PARITY Assume that interest rate parity holds In the spot market 1 Japanese yen = $000907, while in the 90-day forward market 1 Japanese yen =$0,00907, in japan, 90-day risk-free securities yield 2% What is the yield on 90-day risk-free securities in the United State?

Summary Introduction

To determine: The yield of 90 days risk free securities in the Country U.

Interest Rate Parity refers to that theory which indicates the difference of interest rates provided by two different countries is to be same as the difference of two types of the exchange rate, which are forward exchange rate and spot exchange rate.

Explanation

Given information:

The one Country J yen in spot market is $0.00901 The forward rate of one Country J yen is$0.00907.

The yield of 90 days risk free securities is 2% or 0.02.

Equation of interest rate parity:

Forward exchange rateSpot exchange rate=(1+rh)(1+rf)

Where,

• rh is yield in Country U dollars.
• rf is yield in Country J yen.

Formula to calculate 90 days yield:

Yield=rh×36090

The yield of risk free securities in the Country U:

Forward exchange rateSpot exchange rate=(1+rh)(1+rf)$0.00901$0.00901=(1+rh)(1+(0

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