Suppose Japanese yen money market annual rate is .60 % and US money market an an

Question

Suppose Japanese yen money market annual rate is .60 % and US money market an annual rate of 4.50 %.

1. The predictions on the spot rate in 6 months made by financial analysts X and Y are Yen116/$ and Yen 114/$ respectively. If the sport rate today is Yen 115/S, which prediction do you think is more reasonable, why?

2. What should be the spot rate in 6 months based on parity condition?

3. If the forward rate in 6 months is Yen 113/$, will there be arbitrage opportunity, why? if yes then which investments strategy will offer you profit (hit. borrow or lend, dollar, or yen, buy or sell)

4. Suppose you adapt the correct arbitrage strategy with the starting investment value of $43,478.2609 or Yen 5,000,000, what will be the net proceeds?

5. If financial analyst X believes his prediction is right, then what he would do to explore the market profit opportunity?

6. What is the key difference between the strategy adopted by analyst X in part 5 and the strategy in part 4?

Explanation / Answer

1.Money market rate in US (4.50%) is higher in than Japan (0.60%), hence we can say that the Japanese Yen shall be weaker than US $ in future because the demand for US $ shall increase due to higher interest rate. The current Exchange rate is 115/$ so future exchange rate should be higher than this.

So more reasonable prediction shall be 116/$.

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