Question

The nominal yield on 6-month T-bills is 8%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 6%. In the spot exchange market, 1 yen equals $0.006. 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

Forward exchange rate/spot exchange rate = (1+rh)/ (1+rf)

Where rf is the default free interest rate & rh is the interest rate of the home country

Rf is calculated as follows:

6%/2 = 3 %( because 180 days is one half of 360 days in a year)

Rh is calculated as follows:

8%/2 = 4 %( because 180 days is one half of 360 days in a year)

Forward exchange rate/ 0.006 = (1+0.04)/ (1+0.03)

Forward exchange rate = (1+0.04)/ (1+0.03)*0.006

= 1.0097*0.006

= $0.00606

Therefore the forward exchange rate = $0.00606