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# Currencies: Real interest rate, effective return

1.) Suppose the nominal interest rate in the US is 7.5% and US inflation is 3.5%. Also the Canadian dollar spot rate is 0.8574 and the Japanese yen spot rate is 0.00688. Finally, the 90-day forward rate for the Canadian dollar is 0.8493 and for the Japanese yen is 0.00700. If we assume the Fisher equation, interest rate parity, and relative PPP all hold, then the real interest rate in Japan is:
a. 8%
b. 6%
c. 4%
d. 2%

2.) Suppose the nominal interest rate in the US is 7.5% and US inflation is 3.5%. Also the Canadian dollar spot rate is 0.8574 and the Japanese yen spot rate is 0.00688. Finally, the 90-day forward rate for the Canadian dollar is 0.8493 and for the Japanese yen is 0.00700. Suppose you convert your US dollars to Canadian dollars today and invest them in 1-year Canadian bonds yielding 11.2% and you do not buy dollars forward to cover the transaction. One year from today you exchange your Canadian dollars for US dollars at a spot rate of 0.8746. What is the effective return on your investment?
a. 13.2%
b. 9.2%
c. 2%
d. 11.2%

#### Solution Preview

1.)
Suppose the nominal interest rate in the US is 7.5% and US inflation is 3.5%. Also the Canadian dollar spot rate is 0.8574 and the Japanese yen spot rate is 0.00688. Finally, the 90-day forward rate for the Canadian dollar is 0.8493 and for the Japanese yen is 0.00700.

If we assume the Fisher equation, interest rate parity, and relative PPP all hold, then the real interest rate in Japan is:
a. 8%
b. 6%
c. 4%
d. 2%