What can be inferred about the level of interest rate in Japan relative to the level of interest rate in the US: International Financial Management Assignment, MUM, Malaysia

Shrewsbury Herbal Products experienced a negative impact on their business due to the Covid-19 pandemic resulting in unexpected financial losses. In response, the company implemented various financial strategies to recover. However, in September 2022, businesses in UK, Europe, and Japan encountered additional financial uncertainties as a result of the US Federal Reserve’s aggressive interest rate hikes.

The government and the Bank of Japan (BOJ) were concerned about the currency’s sharp decline. Within a week they intervene in the currency market to stem yen weakness by selling dollars and buying yen for the first time since 1998. The yen’s recent sharp declines, which have pushed up households living costs by boosting imported fuel and food prices, have been driven in part by widening divergence between the U.S. Federal Reserve’s aggressive monetary tightening and the BOJ ultra-loose monetary policy.

On Monday the dollar added 0.29% to ¥143.78, continuing its climb back towards last Thursday’s 24-year peak of ¥145.90. It tumbled to ¥140.31 that same day after Japanese authorities stepped into the market. While government officials’ jawboning may keep markets nervous about the prospect of further intervention, stepping in repeatedly in the currency market and selling huge sums of dollars could be difficult due to the criticism Japan may face from its Group of Seven counterparts. “it is unlikely Japan will continue intervening to defend a certain line, such as ¥145 to the dollar,” former top Japanese currency diplomat told Reuters.

The yen is not alone in its downward spiral. Several other currencies, including the British pound, the euro, and the Chinese yuan, have taken a hammering partly driven by the U.S. Federal Reserve’s aggressive interest rate increases in recent months.

1. What can be inferred about the level of interest rate in Japan relative to the level of interest rate in the US?
2. Does the International Fisher Effect hold? Why?
3. If the theory does not hold, which theory can explain the Yen exchange rate?
4. Identify and explain two speculative trading strategies using currency derivatives to benefit from the yen’s depreciation against the dollar.
5. Explain what is the outcome of these strategies if BOJ intervenes in the forex market.

Answer

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