This is for Professor Berry. It is due on 2/1/18 at 7pm.
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Problem 6.3 Derek Tosh and Yen-Dollar Parity | |||||||||||||||||||||
Derek Tosh is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat ¥ | 89.00 | 84.90 | 1.100% | 5.900% | 4.700% | 9.500% | |||||||||||||||
a. | |||||||||||||||||||||
b. | |||||||||||||||||||||
Assumptions | Value | ||||||||||||||||||||
Forecast annual rate of inflation for Japan | |||||||||||||||||||||
Forecast annual rate of inflation for United States | |||||||||||||||||||||
One-year interest rate for Japan | |||||||||||||||||||||
One-year interest rate for United States | |||||||||||||||||||||
Spot exchange rate (¥/$) | |||||||||||||||||||||
One-year forward exchange rate (¥/$) | |||||||||||||||||||||
Approximate Form | |||||||||||||||||||||
Forecast change in | |||||||||||||||||||||
Forward rate as | spot exchange rate | Purchasing | |||||||||||||||||||
an unbaised | ↔ | power | |||||||||||||||||||
predictor (E) | (Dollar expected to weaken) | parity (A) | |||||||||||||||||||
↕ | |||||||||||||||||||||
Forward premium | Forecast difference | ||||||||||||||||||||
on foreign currency | International | in rates of inflation | |||||||||||||||||||
Fisher | |||||||||||||||||||||
(Japanese yen at a premium) | (US higher than Japan) | ||||||||||||||||||||
Interest rate | Difference in nominal | ||||||||||||||||||||
parity (D) | interest rates | effect (B) | |||||||||||||||||||
(higher in United States) | |||||||||||||||||||||
As is the always the case with parity conditions, the future spot rate is implicitly forecast to be equal to the forward rate, the implied rate from the international Fisher effect, and the rate implied by purchasing power parity. According to Yazzie’s calculations, the markets are indeed in equilibrium — parity. | |||||||||||||||||||||
Forcasted change in exchange rates | |||||||||||||||||||||
(Current Spot Rate – Forward Exchange Rate) / (Forward Exchange Rate) |
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Problem 6.7 Takeshi Kamada — CIA Japan (A) | ||||||||||||||
Takeshi Kamada, a foreign exchange trader at Credit Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to invest | $5,000,000 | Japanese yen | ||||||||||||
Assumptions | Value | Yen Equivalent | ||||||||||||
Arbitrage funds available | 593,000,000 | |||||||||||||
Spot rate (¥/$) | 118.60 | |||||||||||||
180-day forward rate (¥/$) | 117.80 | |||||||||||||
180-day U.S. dollar interest rate | ||||||||||||||
4.800% | ||||||||||||||
180-day Japanese yen interest rate | ||||||||||||||
3.400% | ||||||||||||||
Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or expected change in the spot rate for UIA, invest in the higher interest yielding currency. If the difference in interest rates is less than the forward premium (or expected change in the spot rate), invest in the lower yielding currency. | ||||||||||||||
Difference in interest rates ( i ¥ – i $) | -1.400% | |||||||||||||
Forward premium on the yen | 1.358% | |||||||||||||
CIA profit potential | ||||||||||||||
This tells Takeshi Kamada that he should borrow yen and invest in the higher yielding currency, the U.S. dollar, to lock-in a covered interest arbitrage (CIA) profit. | ||||||||||||||
U.S. dollar interest rate (180 days) | ||||||||||||||
$ 5,000,000 | → | 1.0240 | ||||||||||||
↑ | ↓ | |||||||||||||
Spot (¥/$) | —————> 180 days —————-> | Forward-180 (¥/$) | ||||||||||||
593,000,000.00 | ||||||||||||||
START | Japanese yen interest rate (180 days) | END | ||||||||||||
Takeshi Kamada generates a CIA profit by investing in the higher interest rate currency, the dollar, and simultaneously selling the dollar proceeds forward into yen at a forward premium which does not completely negate the interest differential. |