If the no-arbitrage forward exchange rate for a euro in Japanese yen is less than the spot rate, then the interest rate in:
A) Japan is less than in the eurozone
B) the eurozone is less than in Japan
C) Japan is the same as in the eurozone
If the quote is in terms of JPY per EUR, this implies that the JPY is expected to appreciate relative to the EUR. There will be no arbitrage opportunity only if the interest rate in Japan is lower than the interest rate in the eurozone.
To me the quote looks to be Euro / Yen but given the answer it seems it is actually Yen / Euro (?)
"for a euro in Japanese yen " to me implies we are talking about the price of a euro in terms of yen
but if the forward rate is less than the spot then that would mean:
spot = 5 euro / 8 yen
forward = 5 euro / 20 yen
Is it correct in this scenario that the yen is expected to depreciate?
First, CFA Institute’s convention for quoting exchange rates is that A/B 1.2345 means A1.2345 = B1.0.
When they say the exchange rate for a euro in Japanese yen, they mean a JPY/EUR quote. Think of euro as a commodity – a barrel of oil, say – so the exchange rate for euro in yen is like saying the price of oil in yen: you’re paying so many yen for one barrel of oil; you’re paying so many yen for one euro.
If the exchange rate goes from 5 euro / 8 yen (spot) to 5 euro / 20 yen (forward), then the exchange rate for euro has increased – from 1.6 yen to 4 yen – not decreased as stipulated. If the exchange rate goes from 5 euro / 20 yen (spot) to 5 euro / 8 yen (forward), then the exchange rate for euro has decreased.
Thank you for clearing that up.
I still do not understand this question. Can you please elaborate. The doubt is not about exchange rate, I am clear on that part. If JPY appreciates, that means the inflation is lower in Japan compared to eurozone. Inflation is lower and hence interest rate is also lower. Did I understand this correct? Please help.