Answer the Questions
1. When the spot rate is higher than the forward rate, the transaction will result in premium. In this case, the exchange rate of the Yen equivalent to US$ is 0.010043 and the rate after six months is predicted to be 0.010055. The formula for calculating forward premium is.
Forward Premium= 0.010055-0.010043/0.010043= 0.0011948= 0.119 %
The calculation shows that buying rate of JPY is 0.119% higher than dollars on yen. The results also shows that the forward market rate is higher than the spot rate that could give premium . The rate is based on the six-month period so to change the rate to annual we multiply the rate by 2. The annualized forward premium is 0.22% (0.11%*2).
2. It is preferable to buy yen now. The decision is based on the fact that the amount of Yen could be received by compensating one US dollar is 99.58. However, if the currency will be bought after six months it would give 99.45 yen per US dollar. The amount of Yen received is higher than the amount that will be received after six months so it is beneficial to buy the currency now. The potential investors always consider premium for the currency exchange rate. There is 0.22% premium on buying of the Yen at spot rate .
3. According to the Covered-Interest Arbitrage Theory, the interest rate of the United States is expected to be higher up to 2 percent in the next six months. It could be concluded that the interest rate is the obstacle in buying the currency at a forward rate. The expected higher interest rate of the United State might be favorable to the investor as the interest rate is much higher than Japan. The difference in the interest rate will determine that the decision is favorable for buying Yen or there is a need to reverse the decision .
4. The difference in the expected interest rate of Japan and United States is useful for calculating the covered-interest arbitrage. The difference will put influence over the decision-making for the investor. It could further clarified by the calculation given below.
Covered-interest Arbitrage= 2-0.22=1.88 percent
It could be concluded that the expected interest rate difference between the countries must be equal to the spot rate of Yen. The situation is critical for the investor as the expected return is lower than the interest rate difference. It means that for the investor it is preferable to buy the currency if the difference is equal to the spot rate that could not be shown in this case. The investor always consider expected difference rate for decision making and makes a viable decision .
5. International Fisher Effect is a model that suggests that differences in the interest rate (nominal) have impact on the spot exchange rates of two different countries. According to the Fisher Effect, the expected rate of the United States is expected to be higher than the inflation rate of Japan. The inflation rate and interest rate of Japan and United States were compared and the results showed that the inflation rate of Japan was quite low than the interest rate of United States. On comparison, it is revealed that the decision maker has to consider the interest rate of the country with the inflation rate of the other country to make an effective decision .
Griffin, Ricky W. and Mike W. Pustay. International Business: A Managerial Perspective, Student Value Edition. New Jersey: Prentice Hall, 2014. Print.