You observe that the inflation rate in the United States is 1.2 percent per year

Question

You observe that the inflation rate in the United States is 1.2 percent per year and that T-bills currently yield 1.7 percent annually. Use the approximate international Fisher effect to answer the following questions.

What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 7 percent per year? (Enter your answer as a percent rounded 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 10 percent per year? (Enter your answer as a percent rounded 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 12 percent per year? (Enter your answer as a percent rounded to 1 decimal place, e.g., 32.1.)

You observe that the inflation rate in the United States is 1.2 percent per year and that T-bills currently yield 1.7 percent annually. Use the approximate international Fisher effect to answer the following questions.

Explanation / Answer

Solution : According to fisher Real Rf between 2 countries must always be equal under the assumption of perfect market. So : (1 + Ra) / (1 + Rb) = (1 + INF.a)/ (1 + INF.b) Here a and b are 2 different countries and Ra & Rb is risk free rate of that counties. INF is Inflation. (a) a = US b = AUSTRALIA SO (1+0.017) / (1+0.07) = (1+0.012)/ (1+INF.b) (1+INF.b) = 1.012 * 1.07/1.017 INF.b = 1.065 - 1 INF.b = 6.50% (b) a = US b = CANADA SO (1+0.017) / (1+0.10) = (1+0.012)/ (1+INF.b) (1+INF.b) = 1.012 * 1.10/1.017 INF.b = 1.096-1 INF.b = 9.60% ( c) a = US b = TAIWAN SO (1+0.017) / (1+0.12) = (1+0.012)/ (1+INF.b) (1+INF.b) = 1.012 * 1.12/1.017 INF.b = 1.114 - 1 INF.b = 11.40%

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