A Japanese electronics manufacturer is contemplating investing $1 billion (with all of the investment to be made at the outset) in a 10-year investment project in the U.S. The Japanese company is well known in world capital markets and is universally regarded as quite safe. To help finance the project, the company believes it could issue 10-year zero coupon bonds in the U.S. at a yield that would be very close to the current 10-year U.S. Treasury rate of 4%. Alternatively, the company could issue equivalent 10-year zero coupon debt in Japan at an interest rate of 2%. Assume for simplicity that both rates are annually compounded rates. The current spot exchange rate is 89.6 ¥/$.
b) What do you expect the ¥/$ exchange rate to be 10 years from now? How does your forecast help you explain the current differential between interest rates in the U.S. and Japan?