You observe that the inflation rate in the United States is 2.3 percent per year

Question

You observe that the inflation rate in the United States is 2.3 percent per year and that T-bills currently yield 2.8 percent annually.

What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 8 percent per year? (Round your answer to 1 decimal place. (e.g., 32.1))

What do you estimate the inflation rate to be in Canada, if short-term Canadian government securities yield 11 percent per year? (Round your answer to 1 decimal place. (e.g., 32.1))

What do you estimate the inflation rate to be in Taiwan, if short-term Taiwanese government securities yield 13 percent per year? (Round your answer to 1 decimal place. (e.g., 32.1))

What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 8 percent per year? (Round your answer to 1 decimal place. (e.g., 32.1))

Explanation / Answer

- To find all the parts we must first find out the Real return.
Real return = [(1 + nominal return)/(1 + inflation rate)] - 1 = [(1 + 0.028) / (1 + 0.023)] - 1 = 0.0049 or 0.49%

- The Investor expects same real return in every country. Thus, the real return for every country mentioned in part a, b and c will be 0.49%

- Real return = [(1 + nominal return)/(1 + inflation rate)] - 1
This Implies, Inflation rate = [(1 + nominal return)/(1 + real return)] - 1

a. Inflation Rate of Australia = [(1 + 0.08)/(1 + 0.0049)] - 1 = 0.0747 or 7.47%

b. Inflation Rate of Canada = [(1 + 0.11)/(1 + 0.0049)] - 1 = 0.1046 or 10.46%

c. Inflation Rate of Taiwan = [(1 + 0.13)/(1 + 0.0049)] - 1 = 0.1245 or 12.45%

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