In June 2006, a Korean investor is considering investing in bank deposits in Korea and Japan. The annual interest rate on Korean deposits is 6.25%, versus 3.75% on deposits in Japan.
Suppose that the forward rate in June 2006 is equal to won' = 8.2. In June 2006, the expected exchange rate is 8.2 won\.
For the remainder of this question, please use the linear approximations for uncovered and covered interest rate parity. The spot exchange rate in June 2006 is won\ = 8.
a. Does covered interest parity hold in this example? If so, how do you know? Calculate the expected return in Japanese deposits (denominated in Korean won) in this case.