Question

Suppose Japanese yen money market annual rate is .60% and U.S. money market has an annual rate of 4.50%. The predictions on the spot rate in 6 months made by financial analysts X and Y are ¥116/$ and ¥114/$ respectively. If the spot rate today is ¥115/$, which prediction do you think is more reasonable, why?

A) Analysts X, because US dollar interest is higher than Japanese yen, so ¥ should appreciate against $.

B) Analysts X, because US dollar interest is higher than Japanese yen, so ¥ should depreciate against $.

C) Analysts Y, because US dollar interest is higher than Japanese yen, so ¥ should depreciate against $.

D) Analysts Y, because US dollar interest is higher than Japanese yen, so ¥ should appreciate against $.

Answer 1

F = S * (1 + Yen rate * 6/12)/(1 + US rate * 6/12)

F = 115 * (1 + 0.006 * 6/12)/(1 + 0.045 * 6/12)

F = 112.8068459658

F ~ 113 Yen/USD

Yen appreciated because now 1 USD buys only 113 Yen as compared to 115 Yen earlier.

This is close to the prediction made by Analyst Y. And, the correct answer is option D) because US dollar interest is higher than Japanese yen, so ¥ should appreciate against $.

Options A and B are incorrect because Anaylst X was wrong in his prediction.

Option C is incorrect because Yen should appreciate, not depreciate.