FINA 6910 Week 2
Sheet1
| Problem 6.3 Derek Tosh and Yen-Dollar Parity | ||||||
| Derek Tosh is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat ¥89.00/$, while the 360-day forward rate is ¥84.90/$. Forecast inflation is 1.100% for Japan, and 5.900% for the US. The 360-day euro-yen deposit rate is 4.700%, and the 360-day euro-dollar deposit rate is 9.500%. | ||||||
| a. Diagram and calculate whether international parity conditions hold between Japan and the United States. | ||||||
| b. Find the forecasted change in the Japanese yes/U.S. dollar (¥/$) exchange rate one year from now. | ||||||
| Assumptions | Value | |||||
| Forecast annual rate of inflation for Japan | 1.100% | |||||
| Forecast annual rate of inflation for United States | 5.900% | |||||
| One-year interest rate for Japan | 4.700% | |||||
| One-year interest rate for United States | 9.500% | |||||
| Spot exchange rate (¥/$) | 89.00 | |||||
| One-year forward exchange rate (¥/$) | 84.90 | |||||
| a. | ||||||
| Approximate Form | ||||||
| Forecast change in | ||||||
| Forward rate as | spot exchange rate | Purchasing | ||||
| an unbaised | ↔ | ↔ | ↔ | ↔ | power | |
| predictor (E) | (Dollar expected to weaken) | parity (A) | ||||
| ↕ | ↕ | |||||
| ↕ | ↕ | ↕ | ||||
| ↕ | ↕ | ↕ | ||||
| ↕ | ↕ | ↕ | ||||
| ↕ | ||||||
| Forward premium | ↕ | Forecast difference | ||||
| on foreign currency | International | in rates of inflation | ||||
| Fisher Effect (C) | ||||||
| (Japanese yen at a premium) | ↕ | (US higher than Japan) | ||||
| ↕ | ||||||
| ↕ | ↕ | ↕ | ||||
| ↕ | ↕ | ↕ | ||||
| ↕ | ||||||
| Interest rate | ↔ | ↔ | Difference in nominal | ↔ | ↔ | Fisher |
| parity (D) | interest rates | effect (B) | ||||
| (higher in United States) | ||||||
| As is the always the case with parity conditions, the future spot rate is implicitly forecast to be equal to the forward rate, the implied rate from the international Fisher effect, and the rate implied by purchasing power parity. According to Yazzie’s calculations, the markets are indeed in equilibrium — parity. | ||||||
| b. | ||||||
| Spot exchange rate (¥/$) | 89.00 | |||||
| One-year forward exchange rate (¥/$) | 84.90 | |||||
| Forcasted change in exchange rates | ||||||
| (Current Spot Rate – Forward Exchange |