Homework Answers
Current Spot Rate = S = 98 Yen/$ and 1-Year Forward Rate = F = 118 Yen/$
Risk-Free Rate on Yen = YTM of risk-less Yen denominated bond = 1 % = r1
Let the YTM of the USD denominated risk-less bond be r2
As per Interest Rate Parity Equation(IRP): F = S x [(1+r1)/(1+r2)]
If IRP predicted F equals the given 1-Year forward rate, then there would be no-arbitrage.
Hence, 118 = 98 x [(1.01)/(1+r2)]
(1+r2) =(98/118) x (1.01) = 0.8388
r2 = 0.8388 - 1 = - 0.1612 %
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