A Swiss investor’s domestic risk-free rate is 9%. Japanese risk-free rates are 2%. The investor expects the Swiss Franc (SF) to depreciate by 5%. What is the foreign currency risk premium (FCRP)?
The FCRP is the expected appreciation of the foreign currency minus the interest rate differential (domestic – foreign). Hence, the FCRP is –2% (= 5% appreciation of the yen minus 7% interest rate differential). The interest rate differential is calculated as: rDC – rFC = 9% – 2% = 7%).
Under this situation, Since Swiss have higher Rf, we should expect the demand for Swiss Franc going up, hence depreciate of Yen by 7% right?
Since the Franc is depreciated 5%, then shouldn’t the FCRP be -12%?
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