Question

The nominal yield on 6-month T-bills is 7%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 4%. In the spot exchange market, 1 yen equals $0.012. If interest rate parity holds, what is the 6-month forward exchange rate? Round the answer to five decimal places. Do not round intermediate calculations.

Answer 1

Given,

Nominal yield = 7% or 0.07

Default free interest rate = 4% or 0.04

Spot exchange rate = $0.012

Solution :-

6-month nominal yield = 0.07/2 = 0.035

6-month default free interest rate = 0.04/2 = 0.02

Forward exchange rate = Spot exchange rate x [(1 + 6 month nominal yield) (1 + 6 month default free interest rate)]

= $0.012 x [(1 + 0.035) (1 + 0.02)]

= $0.012 x [1.035 1.02]

= $0.012 x 1.01470588 = $0.01218

So, the 6-month forward exchange rate is $0.01218.