Question

Derek Tosh is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat Yen 89.00/$, while the 360-day forward rate is Yen 84.90/$. Forecast inflation is 1.101% for Japan, and 5.905 for the US. The 360-day euro-yen deposit rate is 4.704%, and the 360-day euro-dollar deposit rate is 9.505%.1. Calculate whether international parity conditions hold between Japan and the United States.2. Find the forecasted change in the Japanese Yen/U.S. dollar?

Answer 1

Answer:

1. The markets are indeed in equilibrium  parity . International parity conditions hold between Japan and the United States

2. The forecasted change in the Japanese Yen/U.S. dollar is 4.8%

Explanation:

1. According to th given data we have the following:

Forecast annual rate of inflation for japan = 1.101%

Forecast annaual rate of inflation for US =5.905%

One-year interest rate for Japan = 4.704%

One-year interest rate for United States =9.505%

Spot exchange rate (¥/$)89.00

One-year forward exchange rate (¥/$) = 84.90

The forecast difference in rates of inflation = 1.101%  - 5.905%  = -4.8% (US higher than Japan)

The difference in nominal interest​ rates = -4.8% (higher in United States)

The forward premium on foreign​ currency = 4.8% (Japanese yen at a premium)

The forecast change in spot exchange​ rate = (89 - 84.90) / 84.90 * 100 = 4.8% (Dollar expected to weaken)

As is always the case with parity conditions, the future spot rate is implicitly forecast to be equal to the forward rate, the implied rate fromthe international Fisher effect, and the rate implied by purchasing power parity. Therefore, The markets are indeed in equilibrium -- parity

2.  In order to Find the forecasted change in the Japanese​yen/U.S. dollar​ (¥/$) exchange rate one year from now  we would have to use the following formula:

= (Current Spot Rate - Forward Exchange Rate) / (Forward Exchange Rate)

= (89 - 84.90) / 84.90 *100

= 4.8%

The forecasted change in the Japanese Yen/U.S. dollar is 4.8%