Question

Q2. (5 pts total). Suppose the spot rate is Yen 90/$, the three-month forward rate Yen 88/$ and the three-month yen interest rate 2.5%. (Show your calculations!)

a) (5 pts). What is the implied three-month US$ interest rate?

Answer 1

Spot rate $1 = Yen 90

Forward rate $1 = Yen 88

3-month Yen interest rate = 2.5%

interest for 3-month = 2.5*3/12 = 0.625% or 0.,00625

Forward rate = Spot rate * (1+Yen interest rate for 3 months)/(1+US dollar interest rate for 3 months)

88 = 90 *(1+ 0.00625)/(1+US dollar interest rate)

(1+US dollar interest rate = 90*1.00625/88

US dollar interest rate =1.0291193 - 1

=0.0291193 or 2.91193%

Interest rate for 3 months = 2.91193%

Implied three months interest rate = 2.91193 * 12/3 = 11.64772

So, three months implied interest rate is 11.65%

Note : there is difference between 3 month interest rate and interest rate for 3 months.

Interest rate p.a. which are applicable for 3 month time horizon are three month interest rate.

While interest for 3 months at that rate is called interest rate for 3 months period.