Question

Assume that the international Fisher effect (IFE) holds between the United States and the United Kingdom. The U.S. inflation is expected to be 5 percent, while British inflation is expected to be 3 percent. The interest rate offered on pounds is 7 percent, and the U.S. interest rate is 7 percent. What does this say about real interest rates expected by British investors

Answer 1

Nominal rate of return= 3.9%

Step-by-step explanation:

Inflation is the increase in the price level. It erodes the value of money.

Nominal interest is that quoted for investment or loan transactions. It has not been been adjusted for inflation.

Real interest rate is the amount of interest in terms of the the quantity of good and services that can be purchased. It is the nominal interest rate adjusted for inflation.

The relationship between inflation, real interest and nominal interest rate is given using the Fishers Effect;

N = ( (1+R) × (1+F)) - 1

R= (1+N)/(1+F) -1

N- nominal rate, R-real rate, F- inflation

Real rate of return = 1.07/1.03 - 1= 0.039

Nominal rate of return = 0.039× 100

Nominal rate of return= 3.9%