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

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. 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.

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

Answer 1

According to the uncovered interest rate parity,when there would be appreciation in the interest rate of one currency against the other currency, it would be neutralized by depreciation in value of the similar currency against the other currency so there would not be any positive impact after factoring in currency rates.

In this case, the euro has a higher interest rate than Yen,so in the future market the euros will be depreciating against the Yen in order to compensate for the increase in the interest rates so one can go short on the Euros in order to make money in futures market.

Correct answer will be option (b) which states that, To start a carry trade, a trader can short the Euro against Yen in 3 month forward contract.