The Wall Street Journal lists forward rates for Japanese yen. Say that the curre

Question

The Wall Street Journal lists forward rates for Japanese yen. Say that the current listings are: 1-month forward rate (indirect) 103.17 3-month forward rate (indirect) 102.68 6-month forward rate (indirect) 101.88 First, is the anticipated inflation rate higher or lower in Japan compared to that in the United States? Second, if the current indirect rate is 103.37, what do the six-month rate and the current rate imply about the relative difference in the anticipated annual inflation rates? Finally, using the current indirect rate and the 6-month forward rate, determine the annual anticipated inflation rates for Japan if the U.S. inflation rate is anticipated to be 3.45%.

Explanation / Answer

1) The one month forward rate Y/$ is 103.17, the two month rate is 102.68 and the 6 month rate is 101.88. As the number of Yens per $ is decreasing with passage of time, the Yen is appreciating and the $ is depreciating. As per the IRPT, the depreciating currency will have higher inflation and the appreciating currency will have lower inflation. Hence, the inflation rate is lower in Japan when compared to the inflation rate in US. 2) As per the IRPT the forward rate S1 = Spot rate (S0)*[1+(ih-if)] where, ih = inflation rate in home currency and if= inflation in foreign currency. As the quotes are for $ in terms of Yen, the Yen is the home currency and the $ the foreign currency. Substituting available values we have 101.88 = 103.37*[1+(ih-if)] 101.88/103.37 - 1 = (ih-if) = -0.0144 The negative value implies that the home (Y) inflation rate is lower than the foreign currency ($) inflation rate by 1.44% for the half year. The difference on an annual basis will be 2.88% 3) Anticipated Japanese inflation rate = 3.45 - 2.88 = 0.57% A more accurate calculation would be: 101.88 = 103.37*(1+ih/2)/(1+0.0345/2) ih/2 = (101.88/103.37)*(1+0.0345/2)-1= 0.002587 ih = 0.002587*2 = 0.52% CHECK: =103.37*(1+0.0052/2)/(1+0.0345/2) = 101.88Y/$

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