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Six-month T-bills have a nominal rate of 3%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 1

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Six-month T-bills have a nominal rate of 3%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 1.15%. In the spot exchange market, 1 yen equals $0.0078. If interest rate parity holds, what is the 6-month forward exchange rate? Do not round intermediate calculations. Round your answer to five decimal places.

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As per interest rate parity theory exchange rate difference between two countries is reflected in interest rate difference between two countries

As per interest rate pariy , theoreticaltheoretical future exchange rate is given by

$S{_{f}} = S{_{o}} \frac{(1+i{_{f}})}{1+i{_{h}}}$

Where $S{_{f}}$ is future spot rate or forward rate

$S{_{o}}$ is today exchange rate

$i{_{f}}$ is interest rate of foreign country

$i{_{h}}$ is interest rate of home country

Spot rate is 1¥ = $0.0078

We know that in direct quote one unit of home currency is expressed in units of foreign currency

So home currency is japanese yen and foreign currency is dollars

We should use interest rate for 6 months since we are caluculating forward rate for 6 months

6 months T bill interest rate = 3% * 6/12 = 1.5%

6 Months japanese bonds interest rate = 1.15%*6/12 = 0.575%

Forward rate for 6 months is,

= 0.0078 * (1+0.015)/(1+0.00575)

= 0.0078* 1.015/1.00575

= $0.00787

6 months forward rate is 1 yen = $ 0.00787

Six-month T-bills have a nominal rate of 3%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 1

Finance