Currency per U.S. $ Australia dollar 1.2372 6-months forward 1.2361 Japan Yen 10

Question

Currency per U.S. $ Australia dollar 1.2372 6-months forward 1.2361 Japan Yen 100.2800 6-months forward 100.1000 U.K. Pound .6797 6-months forward .6776 Suppose interest rate parity holds, and the current risk-free rate in the United States is 4 percent per six months. Use the approximate interest rate parity equation to answer the following questions. Requirement 1: What must the six-month risk-free rate be in Australia? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Risk-free rate % Requirement 2: What must the six-month risk-free rate be in Japan? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Risk-free rate % Requirement 3: What must the six-month risk-free rate be in Great Britain? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Risk-free rate %

Explanation / Answer

Answer:- We can rearrange the approximate interest rate parity condition to answer this question. The equation we will use is: RFC= (Ft– S0)/S0+ RUS Using this relationship, we find: 1: Australia: RFC= (C$1.2361 – C$1.2372)/C$1.2372 + 0.04 = 0.03912 or 3.91% 2: Japan: RFC= (¥100.1000 – ¥100.28)/¥100.28 + 0.04 = 0.0382 or 3.82% 3: Great Britain: RFC= (£0.6776 – £0.6797)/£0.6797 + 0.04 = 0.0369 or 3.69%

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