2. In June 2006, a Korean investor is considering investing in bank deposits in Korea and Japan. The annual interest rate on Korean deposits is 6.25%, versus 3.75% on deposits in Japan. Suppose that the forward rate in June 2006 is equal to Fwon/¥ = 8.2. In June 2006, the expected exchange rate is 8.2 won/¥. For the remainder of this question, please use the linear approximations for uncovered and covered interest rate parity. The spot exchange rate in June 2006 is Ewon/¥ = 8. a. Does covered interest parity hold in this example? If so, how do you know? Calculate the expected return in Japanese deposits (denominated in Korean won) in this case. b. Does uncovered interest parity hold in this example? If so, how do you know? If not, what is the implied risk premium? Which deposits pay a higher expected return? Calculate the return on Japanese deposits (denominated in Korean won) in this case. c. Suppose the exchange rate in June 2007 is equal to 8.528 won per ven. Calculate the Korean investor's actual return.
2. In June 2006, a Korean investor is considering investing in bank deposits in Korea and Japan. The annual interest rate on Korean deposits is 6.25%, versus 3.75% on deposits in Japan. Suppose that the forward rate in June 2006 is equal to Fwon/¥ = 8.2. In June 2006, the expected exchange rate is 8.2 won/¥. For the remainder of this question, please use the linear approximations for uncovered and covered interest rate parity. The spot exchange rate in June 2006 is Ewon/¥ = 8. a. Does covered interest parity hold in this example? If so, how do you know? Calculate the expected return in Japanese deposits (denominated in Korean won) in this case. b. Does uncovered interest parity hold in this example? If so, how do you know? If not, what is the implied risk premium? Which deposits pay a higher expected return? Calculate the return on Japanese deposits (denominated in Korean won) in this case. c. Suppose the exchange rate in June 2007 is equal to 8.528 won per ven. Calculate the Korean investor's actual return.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:2. In June 2006, a Korean investor is considering investing in
bank deposits in Korea and Japan. The annual interest rate
on Korean deposits is 6.25%, versus 3.75% on deposits in
Japan. Suppose that the forward rate in June 2006 is equal
to Fwon/¥= 8.2. In June 2006, the expected exchange rate
is 8.2 won/¥. For the remainder of this question, please use
the linear approximations for uncovered and covered
interest rate parity. The spot exchange rate in June 2006 is
Ewon/¥ = 8.
a. Does covered interest parity hold in this example? If so,
how do you know? Calculate the expected return in
Japanese deposits (denominated in Korean won) in this
case.
b. Does uncovered interest parity hold in this example? If so,
how do you know? If not, what is the implied risk
premium? Which deposits pay a higher expected return?
Calculate the return on Japanese deposits (denominated in
Korean won) in this case.
c. Suppose the exchange rate in June 2007 is equal to 8.528
won per yen. Calculate the Korean investor's actual return,
assuming that he invests in Japanese deposits in June 2006.
How do these answers compare with those from (b)?
d. Consider two Korean investors: one uses speculation and
the other uses hedging. Based on your previous answers,
which one earned a higher return (or smaller loss) on
Japanese assets between June 2006 and 2007? Explain
briefly why.
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