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Assume that the annual U.S. interest rate is currently 8 percent and Japan's annual interest is currently 7

percent. The spot rate of the Japanese yen is $.01. The 1-year forward rate of the Japanese yen is $.01. Assume that as covered interest arbitrage occurs the interest rates are not affected and the spot rate is not affected. Explain how the 1-year forward rate of the yen will change in order to restore interest rate parity, and why will it change.

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