Question

Assume that interest rate parity holds. In the spot market 1 Japanese yen = $0.00905, while in the 90-day forward market 1 Japanese yen = $0.00913. In Japan, 90-day risk-free securities yield 1%. What is the yield on 90-day risk-free securities in the United States? Do not round intermediate calculations. Round your answer to two decimal places. %

Answer 1

The yield on 90-day risk-free securities in the United States can be calculated using interest rate parity. According to interest rate parity, the difference in interest rates between two countries should be equal to the forward premium or discount for the currency. In this case, the yield is 12.5%.

Step-by-step explanation:

The yield on 90-day risk-free securities in the United States can be calculated using interest rate parity. According to interest rate parity, the difference in interest rates between two countries should be equal to the forward premium or discount for the currency.

1. First, calculate the forward premium or discount by subtracting the spot exchange rate from the forward exchange rate. In this case, the forward premium is $0.00913 - $0.00905 = $0.00008.
2. Next, calculate the difference in interest rates between Japan and the United States. The 90-day risk-free rate in Japan is 1%, so the difference in interest rates is 1% - 0% = 1%.
3. Finally, use the formula for interest rate parity: forward premium = (1 + foreign interest rate) / (1 + domestic interest rate) - 1.

Plugging in the values, we have $0.00008 = (1 + 0.01) / (1 + US interest rate) - 1.

Solving for the US interest rate, we get:

US interest rate = ((1 + 0.01) / $0.00008) - 1 = 1.125 - 1 = 0.125 = 12.5%.

Therefore, the yield on 90-day risk-free securities in the United States is 12.5%.