Suppose the spot and threemonth forward rates for the yen ar

Suppose the spot and three-month forward rates for the yen are *79.80 and *79 12, respectively What would you estimate is the difference between the annual inflation rates of the United States and Japan? (Negative amount should be indicated by a minus sign. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16) Annual inflation rate differential References

Solution

Inflation Rate = (¥79.12 - ¥79.80) / ¥79.80 = -¥0.68/¥79.80 = -0.0085, or -0.85%

Annual Inflation Rate Differential = [1 + Inf.]ⁿ - 1

= [1 + (-0.0085)]⁴ - 1

= [0.9915]⁴ - 1 = 0.9663 - 1 = -0.0337, or -3.37%