Question

if the spot rate for the yen is .0085 yen is equal to 1 us $, and the annual interest rate on fixed rate one year deposits of yen is 0.2 % and for US $ is 1.5 % what is nine month forward rate for one dollar in terms of yen? assuming the same interest rates, what is the 18 month forward rate for yen in US $ ? is this an indirect or a direct rate? if the forward rate is an accurate predictor of exchange rates in this case will the yen get stronger or weaker against the dollar? what does this indicate about the markets inflation expectation for japan as compared to the US

Answer 1

Forward rate calculation will use the formula for covered interest rate parity:

18 months rate is calculated below:

9 months rate is calculated below:

A direct quote is the one in which the price of 1 unit of foreign currency is given in terms of domestic currency and it is indirect when the opposite is true. If we assume that the investor is from US, then the quote is an indirect one.

When forward rates are unbiased predictors of the expected spot rates, then uncovered interest rate parity holds. It says that the currency with higher interest rate will depreciate and that with lower interest rate will appreciate and this movement in exchange rate will be offset by the movement in inflation which will move in opposite direction of the exchange rate.

So from above calculation, we can say that Yen will appreciate against USD but it will experience higher inflation also to offset this gain. So the inflation in Japan will be higher than US