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# Are for 90 day periods we assume they are quoted as

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are for 90-day periods, we assume they are quoted as bond equivalent yields, annualized using simple interest. Therefore, to express rates on a per quarter basis, we divide these rates by 4: Japanese government Swiss government Convert \$1 million to local currency \$1,000,000 × 133.05 = ¥133,050,000 \$1,000,000 × 1.5260 = SF1,526,000 Invest in local currency for 90 days ¥133,050,000 × [1 + (0.076/4)] = ¥135,577,950 SF1,526,000 × [1 + (0.086/4)] = SF1,558,809 Convert to \$ at 90-day forward rate 135,577,950/133.47 = \$1,015,793 1,558,809/1.5348 = \$1,015,643 b. The results in the two currencies are nearly identical. This near-equality reflects the interest rate parity theorem. This theory asserts that the pricing relationships between interest rates and spot and forward exchange rates must make covered (that is, fully hedged and riskless) investments in any currency equally attractive. c. The 90-day return in Japan is 1.5793%, which represents a bond-equivalent yield of 1.5793% × 365/90 = 6.405%. The 90-day return in Switzerland is 1.5643%, which represents a bond-equivalent yield of 1.5643% × 365/90 = 6.344%. The estimate for the 90-day risk-free U.S. government money market yield is in this range. 23-6

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15. The investor can buy X amount of pesos at the (indirect) spot exchange rate, and invest the pesos in the Mexican bond market. Then, in one year, the investor will have: X × (1 + r MEX ) pesos These pesos can then be converted back into dollars using the (indirect) forward exchange rate. Interest rate parity asserts that the two holding period returns must be equal, which can be represented by the formula: (1 + r US ) = E 0 × (1 + r MEX ) × (1/ F 0 ) The left side of the equation represents the holding period return for a U.S. dollar- denominated bond. If interest rate parity holds, then this term also corresponds to the U.S. dollar holding period return for the currency-hedged Mexican one-year bond. The right side of the equation is the holding period return, in dollar terms, for a currency-hedged peso-denominated bond. Solving for r US : (1 + r US ) = 9.5000 × (1 + 0.065) × (1/9.8707) (1 + r US ) = 1.0250 r US = 2.50% Thus r US = 2.50%, which is the as the yield for the one-year U.S. bond. 16. a. From parity: 06453 . 122 0380 . 1 0010 . 1 30 . 124 r 1 r 1 E F 5 . 0 5 . 0 Japan US 0 0 = × = + + × = b. Action Now CF in \$ Action at period-end CF in ¥ Borrow \$1,000,000 in U.S. \$1,000,000 Repay loan (\$1,000,000 × 1.035 0.25 ) = \$1,008,637.45 Convert borrowed dollars to yen; lend ¥124,300,000 in Japan –\$1,000,000 Collect repayment in yen ¥124,300,000 × 1.005 0.25 = ¥124,455,084.52 Sell forward \$1,008,637.45 at F 0 = ¥123.2605 0 Unwind forward (1,008,637.45 × ¥123.2605) = ¥124,325,156.40 Total 0 Total ¥129,928.12 The arbitrage profit is: ¥129,928.12 17. The farmer must sell forward: 100,000 × (1/0.90) = 111,111 bushels of yellow corn This requires selling: 111,111/5,000 = 22.2 contracts 23-7
18. Municipal bond yields, which are below T-bond yields because of their tax-exempt

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are for 90 day periods we assume they are quoted as bond...

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