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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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INTEREST RATE PARITY Assume that interest rate parity holds. In the spot market 1 Japanese yen = $0.008055, while in the 90-day forward market 1 Japanese yen $0 008065. In Japan, 90-day risk-free securities yield 2%. What is the yield on 90-day risk-free securities in the United States?

Summary Introduction

To determine: The yield of 90 days risk free securities in the United States.

Introduction:

Interest Rate Parity:

It 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 Japanese yen in spot market is $0.008055.

The forward rate of one Japanese yen is $0.008065

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 US dollars.
  • rf is yield in Japanese yen.

Substitute $0.008065 for forward rate, $0.008055 for spot exchange rate, (0.02×90360) for rf in the above formula.

$0.008065$0.008055=(1+rh)(1+(0

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