Calculate the expected return in japanese deposits

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Reference no: EM133367578

Question 1. 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 . 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

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.

This question uses the general monetary model, where L is no longer assumed constant and money demand is inversely related to the nominal interest rate. Consider the same scenario described at the beginning of the previous question. In addition, the bank deposits in
Japan pay a 3% interest rate,

a. Compute the interest rate paid on South Korean won deposits.

b. Using the definition of the real interest rate (nominal interest rate adjusted for inflation), show that the real interest rate in South Korea is equal to the real interest rate in Japan. (Note that the inflation rates you computed in the previous question will be the same in this question.)

c. Suppose the Bank of Korea decreases the money growth rate from 15% to 12% and the inflation rate falls proportionately (one for one) with this increase. If the nominal interest rate inJapan remains unchanged, what happens to the interest rate paid on Korean won deposits?

d. Using time series diagrams, illustrate how this decrease in the money growth rate affects the money supply ; South Korea's interest rate; prices ; real money supply; and over time. (Plot each variable on the vertical axis and time on the horizontal axis

Reference no: EM133367578

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