Question

A U.S. multinational is considering opening a subsidiary in Japan. The management is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat JPY/USD = 89.00, while the 360-day forward rate is JPY/USD = 84.90. Forecast inflation is 1.1% for Japan and 5.9% for the United States. The 360-day interest rate in Japan is 4.7%, and the 360-day interest rate in US is 9.5%. Calculate whether interest rate parity holds between Japan and the United States.

Answer 1

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As per Interest rate parity:

As per Interest rate parity the difference in spot fate and forward rate exits due to differences in interest rate between two countries.

F/S = (1+ra)/(1+rb)

F= forward rate 84.90

S = spot rate. 89

ra = interest rate of price currency. 0.047

rb= interest rate of base currency. 0.095

F/S = 84.90/89 = 0.954

(1+ra)/(1+rb) = (1+0.047)/(1+0.095)= 0.956

Expected forward rate = [(1+0.047)/(1+0.095)]×89 = 85

The Interest rate parity almost holds good between the two countries.

Ignoring minute variability,

It can be said that interest rate parity holds good.