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# Interest Rate & Purchasing Power Parity

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1. Interest Rate Parity

Six month T-bills have a nominal rate of 7%, while default free Japanese bonds that mature in 6 months have a nominal rate of 55%. In the spot exchange market, I yen equals \$0.009. If interest rate parity holds, what is the 6 months forward exchange rate?.

A television set costs \$500 in the United States. The same set costs 550 euros in France. If purchasing power parity holds, what is the spot exchange rate between the euro and the dollar?

3. Result of Exchange Rate Changes:

Early in September 1963, it took 246 Japanese yen to equal \$1. More than 20 years later that exchange rate had fallen to 108 yen to \$1. Assume the price of a Japanese were in direct relation to exchange rates.

a-Has the price, in dollars, of the automobile increased or decreased during the 20 years period because of changes in the exchange rate?

b-What would the dollar price of the car be, assuming the car's price changes only with exchange rates?

#### Solution Preview

Financial Management Problems:

Problem 26-2 (Interest Rate Parity):

Six month T-bills have a nominal rate of 7%, while default free Japanese bonds that mature in 6 months have a nominal rate of 5.5%. In the spot exchange market, 1 yen equals \$0.009. If interest rate parity holds, what is the 6 months forward exchange rate?

Spot rate = \$0.009/yen

F = S x 1 + US rate
1 + Japanese rate

Since the nominal rate ...

#### Solution Summary

This solution shows all calculations needed to calculate the interest rate parity, purchasing power parity, and to investigate the result of exchange rate changes in 301 words.

\$2.49