Suppose that 2-year interest rates are 5.2% in the United States and 1.0% in Japan. The spot

Question:

Suppose that 2-year interest rates are 5.2% in the United States and 1.0% in Japan. The spot exchange rate is JPY83.63 = USD1. Suppose that 1 year later interest rates are 3% in both countries, while the value of the yen has appreciated to JPY80.00 = USD1.

a. Benjamin Pinkerton from New York invested in a U.S. 2-year zero-coupon bond at the start of the period and sold it after 1 year. What was his return?

b. Madame Butterfly from Osaka bought some dollars. She also invested in the 2-year U.S. zero-coupon bond and sold it after 1 year. What was her return in yen?

c. Suppose that Madame Butterfly had correctly forecast the price at which she sold her bond and that she hedged her investment against currency risk. What would have been her return in yen?

Exchange Rate
The value of one currency for the purpose of conversion to another. Exchange Rate means on any day, for purposes of determining the Dollar Equivalent of any currency other than Dollars, the rate at which such currency may be exchanged into Dollars...