Japan Exchange Rate Regime Essay Example | Topics and Well Written Essays - 1250 words

Japan Exchange Rate Regime - Essay Example The major currency that is used in Japan is Yen and all matters related to the currency were normally administered by the Ministry of Finance. However, the administration was carried out with the cooperation of the Ministry of International Trade (MITI) and Industry and the bank of Japan. MITI also handled licenses related to exports and imports. However, the authority for approving major payments was given to the authorized banks in Japan.Studies reveal that trade in Japan was being regulated by the government directly before 1949. During this time, the country practiced multiple exchange rates. However, the direct control by the government was gotten rid of in 1949 and a new system that was meant to regulate foreign trade was introduced since the market economy was under transition. This was meant to ensure that the foreign trade system in the country would be compatible with the market economy that was in transition. Japan also shifted from plural exchange rate regime to the singl e exchange rate regime. This regime continued to play as the dominant force in Japan until the early 1960s. The major force that interrupted the performance of the Japanese currency was the US dollar. In this case, Japan sustained a fixed exchange rate of 360.00 Yen for every US dollar up to 1971. However, in 1971, the Yen was permitted to float above its fluctuation ceiling whereby an effective fluctuation rate was implemented. However, since the US dollar continued to devalue, the Bank of Japan was forced to place a control that would regulate the exchange rate and facilitate a floating basis . (Trading Economics b, 2012). The Effective rate of Japan was later set in a manner that allowed it to float in a free manner. However, since the floating exchange rate was introduced in Japan in 1973, the economy of Japan has been experiencing significant fluctuations while dealing with foreign exchange rates. The Interbank Rate was also in traduced in Japan in 1973. In this case, the Yen w as supposed to be determined on the basis of the demand and supply forces in the Japanese economy. The bank of Japan was only supposed to intervene whenever the Yen was observed to be fluctuating in an abnormal manner in the currency market (The Chinese University of Hong Kong, 2000). Discuss three relationships that describe the behavior of exchange rate Covered Interest Rate Parity (CIP) Interest rate parity describes an equilibrium situation whereby investors are normally indifferent regarding the interest rates that are available on the bank deposits between two countries. However, since this condition does not always hold, investors are normally provided with an opportunity to earn riskless profits while under the covered interest arbitrage mechanisms (Economy watch, 2012). Therefore, in the case where the no-arbitrage condition is satisfied while under the use of a forward contract that would help to hedge against the risks that are present in the exchange rate markets. In thi s case, the interest rate is described as covered. In this case, the forward exchange rate sustains an equilibrium state (Trading Economics b, 2012). In this case, the return on the dollar to dollar deposits normally equals to the return on the dollar to foreign deposits. This means that the potential for making profits in the case of covered interest arbitrage is eliminated. Moreover, the covered interest rate parity also helps while determining forward exchange rate. For example, assuming japans currency trades at par with the US currency and the interest rate in Japan is 6 percent while the interest rate in the US is 3 percent, then it would be advisable to borrow the currency of the US and convert it in the spot market to the currency of Japan when all other factors are held