Question

You have $1,000,000 to start with. Yen Spot rate =106 Yen/$ Yen FWD Rate=103.5 Yen/$ Interest rates in Japan are 4% per album (2% for 6 months). Interest Rate in the USA are 8% per annum(4% for 6 months) for securities of similar risk and maturity. What should you do?

Answer 1

To start with I have $1,000,000.

I will buy Yen at Current Spot Rate of 106Yen/$ which will amount to 106,000,000 Yen. I will invest this amount in Japan for 6 months at 2%.

At the same time, I will also enter into Forward Contract to sell 108,120,000 Yen (=106,000,000 x 1.02) at the FWD Rate= 103.5 Yen/$ and buy dollar after six months.

So, after 6 months I will have $1,044,637.681 after converting back my investment into US$.

Instead of working all this arrangement, if I had simply invested my dollar in USA @4% for 6 months I would have received $1,040,000.

So, by investing in Japan and entering into Forward Contract I have made an additional profit of $4,637.68 ($1,044,637.681-$1,040,000).