Hey Chegg, I am having trouble with this problem and I could really use your hel
ID: 2798175 • Letter: H
Question
Hey Chegg, I am having trouble with this problem and I could really use your help in solving it.
1) We know that the yen and the Swiss franc have a 100 yen/ sf l exchange rate, meaning one swiss franc buys 100 yen in the spot ER market. The 1 year forward rate is 80 yen /swiss franc, or 1 swiss franc buys 80 yen in the forward market. If the swiss franc has an interest rate of .1, what should the yen rate be for IPT (interest parity theory) to be attained? If the yen rate were 6%, would there be equilibrium? If so, what would transpire? Show both amounts and differentials. Also, show everything in both yen and swiss franc terms.
Below are the formulas that my professor has provided. Maybe you can use it as a guide.
Interest Rate Parity Theory: I. Equilibrium A. In Amounts
Dollar Terms ($/E):
$P (1 + i$) = $P [1 / $/ES] (1 + iE) ($/EF)
i$ = interest rate of domestic currency
iE = interest rate of foreign currency
$/ES = spot exchange rate in euro
$/EF = forward rate in dollar
Euro Terms (E/$):
$P (1 + i$) = $P (E/$S) (1 + iE) (1 / E/$F)
i$ = interest rate of domestic currency
iE = interest rate of foreign currency
E/$S = spot exchange rate in euro
E/$F = forward rate in euro
Interest Rate Parity Theory: I. Equilibrium B. In Percentages or Differentials
Dollar Terms ($/E):
i$ - iE / 1 + IE = $/EF - $/ES / $/ES
Euro Terms (E/$):
i$ - IE / 1 + iE = E/$S - E/$F / E/$F
I am used to solving these problems when dealing with the $ and the euro. But, now I am dealing with Japanese Yen and Swiss Franc, which are both foreign currencies. Using the formulas that I provided above in trying to show amount and percentages, which currency becomes domestic and which currency becomes foreign. This is where I am confused. Please show this problem for me using the formulas above and please show work so I can understand it clearly. I seem to be stuck.
Explanation / Answer
Forward rarte = Spot rate*(1+Domestic rate) / (1+Foreign rate)
100 yen/ sf => Sf is foreign, always denominator is foreign and numerator is domestic
80 = 100*(1+Rd) / (1+0.1)
Rd = 80*1.01/100 = 0.808 = 8.08%
b)
If Rd = 6%
Forward rarte = 100*(1+6%)/(1+10%) = 96.37 Yen / Franc
Spot = 100
difference = (96.37 - 100)/100 = -3.64%
Or (6% - 10%) / (1+10%) = -3.64%