FINA 6910 Week 2

This is for Professor Berry. It is due on 2/1/18 at 7pm. 

Sheet1

/$, while the 360-day forward rate is ¥

/$. Forecast inflation is

for Japan, and

for the US. The 360-day euro-yen deposit rate is

, and the 360-day euro-dollar deposit rate is

.

Diagram and calculate whether international parity conditions hold between Japan and the United States.

Find the forecasted change in the Japanese yes/U.S. dollar (¥/$) exchange rate one year from now.

1.100%

5.900%

4.700%

9.500%

89.00

84.90

a.

↔ ↔ ↔

↕
↕ ↕ ↕

↕ ↕ ↕
↕ ↕ ↕
↕

↕

Effect (C)

↕

↕
↕ ↕ ↕
↕ ↕ ↕
↕

↔ ↔

↔ ↔ Fisher

b.

Spot exchange rate (¥/$) 89.00
One-year forward exchange rate (¥/$) 84.90

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)

Sheet1

or its yen equivalent, in a covered interest arbitrage between U.S. dollars and

. He faced the following exchange rate and interest rate quotes.

$5,000,000

4.800%

→

→ →

↑ ↓
↑ ↓
↑ ↓
↑ ↓

118.60 117.80

↑ ↓
↑ ↓

↑

→ → → →

Japanese yen

3.400%

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.