Question

The following data are? given:

Et

? =

yen

105

?= $1.00

Et?+1

? =

yen

109

?= $1.00

iU.S.

? =

12

?%

If the interest parity condition is expected to? hold, interest rates in Japan should equal

nothing

?%.

?(Round your response to two decimal

places.?)

Answer 1

Covered interest rate parity refers to a theoretical condition in which the relationship between interest rates and the spot and forward currency values of two countries are in equilibrium. Additionally, the covered interest rate parity refers to the situation in which the no-arbitrage condition is satisfied with the use of forward contracts.

Formula

Under the covered interest rate parity, the following formula must hold true, otherwise there would be an arbitrage opportunity: (1 + id) = (S / F) * (1 + if).

Here S=105, F=109, if = 12

Plugging in the equation

105/109 * (1+.12) = 1.0788

So I'd = 7.88 should be the interest rate of Japan