Question

The interest rate for Swiss Franc is i_SF=12% and for Japanese yen is i_¥=10%. The expected inflation rate in Switzerland for the next year is 5%. According to the International Fisher Effect, the expected inflation rate and real interest rate in Japan for next year are respectively,

Select one:

a. 2.1% and 4.1%

b. 3.5% and 7.0%

c. 3.1% and 6.7%

d. 2.0% and 5.0%

e. 7.0% and 7.0%

Answer 1

Real interest rate is computed as shown below:

= [ (1 + interest rate for Swiss Franc) / (1 + expected rate of inflation in Switzerland) ] - 1

= [ (1 + 0.12) / (1 + 0.05) ] - 1

= 6.66666667% or 6.7% Approximately

Expected inflation rate is computed as follows:

= [ (1 + interest rate of Japanese Yen) / (1 + real interest rate computed above) ] - 1

= [ (1 + 0.10) / (1 + 0.06666667) ] - 1

= 3.1% Approximately

So, the correct answer is option c.

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