Question

The three-month interest rate on yen is i_¥=1% per annum; the three-month interest rate on euros is i_€=5.5% per annum. Which one of the following statements is correct?

Select one:

a. Based on the Uncovered Interest Rate Parity, the euro is expected to appreciate by 4.5% against yen next three months.

b. In a carry trade between euro and yen for three months, the profit will be ¥0.0315(for each yen borrowed) if the euro has appreciated 2% against yen in the three months.

c. According to the asset market approach, the current spot rate should be ¥1.293/€ if the expected three-month spot rate S₃(¥/€)=1.250.

d. The euro is going to appreciate in the next year.

e. To start a carry trade, a trader can short the euro against yen in three-month forward contracts.

Answer 1

In this scenario,the interest rate on euro is higher than the interest rate on yen so according to the uncovered interest rate parity, next three months the euro is going to depreciate against and so it is better to go short on Euro.

according to the uncovered interest rate parity the difference in the nominal interest rate will be equalised by the difference in the currency exchange rate.

So the correct answer will be option (e)to start a carry trade, trader can short Euro against Yen in 3 month forward contract.

all the other options are false because they are mostly advocating for appreciation of Euro.