Question

The spot rate for the CRL is $0.0587/CRL. The U.S. inflation rate is anticipated to be 2.8%. The Country L inflation rate is expected to be 5.8%. Both countries are expected to have a real interest rate of 1.2%. Show calculations.

a.)Based on the Fisher effect, calculate the U.S. nominal interest rate.

b.) Based on the Fisher effect, calculate the Country L nominal interest rate.

c.)Using the international Fisher effect, calculate the expected spot rate in 3 years.

Answer 1

a.) U.S. nominal interest rate = [(1+real interest rate)*(1+ U.S. inflation rate)] - 1 = [(1+0.012)*(1+0.028)] - 1 = (1.012‬*1.028‬) - 1 = 1.0403 - 1 = 0.0403 or 4.03%

b.) Country L nominal interest rate = [(1+real interest rate)*(1+ Country L.inflation rate)] - 1 = [(1+0.012)*(1+0.058)] - 1 = (1.012‬*1.058‬) - 1 = 1.0707 - 1 = 0.0707 or 7.07%

c.) expected spot rate in 3 years = spot rate*[(1+Country L nominal interest rate)no. of years/(1+U.S. nominal interest rate)no. of years)]

expected spot rate in 3 years = $0.0587/CRL*[(1+0.0707)3/(1+0.0403)3] = $0.0587/CRL*(1.07073/1.04033) = $0.0587/CRL*(1.227448863243‬/1.125837720827) = $0.0587/CRL*1.0902538088183438196645513539353 = $0.0640/CRL

expected spot rate in 3 years is $0.0640/CRL.