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The Asian Spec Fund, managed by Jonathan Khamal, CFA, engages in currency speculation for its clients. Based in Paris, Khamal believes that there is an opportunity to speculate on the Malaysian Ringgit. The current spot exchange rate is 4.417 Malaysian Ringgit per euro. He believes that the international Fisher relation holds on the assumption that the ratios of interest and inflation rates are equal among developed and emerging countries. For comparative purposes, one of Malaysia’s main financial trading partners is Europe. The current nominal interest rate for the European Economic Community is 11.76% and the annual inflation rate is 8.50%. The Malaysian nominal interest rate is 7.60% and the annual inflation rate is 4.50%. According to his calculations, the result of the international Fisher relation and its linear approximation are:

Using the international Fisher relation:

Exact methodology: (1 + r_FC) / (1 + r_DC) = (1 + E (i_FC)) / (1 + E (i_DC))

Linear approximation: r_FC – r_DC = E (i_FC) – E (i_DC)

By substituting for the international Fisher relation:

(1 + 0.076) / (1 + 0.1176) = (1 + 0.045) / (1 + 0.085)
1.076 / 1.1176 ≈ 1.045 / 1.085
0.9628 ≈ 0.9631

By substituting for the linear approximation of the international Fisher relation:

0.076 – 0.1176 ≈ 0.045 – 0.085
- 0.0416 ≈ -0.0400

Michael Zotov, CFA, is the economist and portfolio manager of the Zotov Investment Fund based in Germany. Zotov believes that the Polish economy is due for a significant recovery as a result of governmental austerity programs enacted this year. Nominal interest rates and inflation have begun to trend lower. For comparative purposes, he wanted to use Europe as a benchmark since most of his investor base is in Germany. The current spot exchange rate is 4.6404 Polish Zioty per euro. He wants to see if the ratio of interest rates between Poland and the European Economic Community (EEC) are the same as the ratio of inflation rates according to the international Fisher relation. The current nominal interest rate for the EEC is 11.76% and the annual inflation rate is 8.50%. The Polish nominal interest rate is 12.30% and the annual inflation rate is 9.00%. According to his calculations, the result of the international Fisher relation and its linear approximation are:

Using the international Fisher relation:

Exact methodology: (1 + r_FC) / (1 + r_DC) = (1 + E(i_FC)) / (1 + E (i_DC))

Linear approximation: r_FC – r_DC = E(i_FC) – E(i_DC)

By substituting for the international Fisher relation:

(1 + 0.123) / (1 + 0.1176) = (1 + 0.09) / (1 + 0.085)
1.123 / 1.1176 ≈ 1.09 / 1.085
1.0048 ≈ 1.0046
1.005 ≈ 1.005

By substituting for the linear approximation of the international Fisher relation:

0.123 – 0.1176 ≈ 0.09 – 0.085
0.0054 ≈ 0.0050
0.005 ≈ 0.005

Simon Peak, CFA, an international trader and economist for Canyon Peak Trading, feels that the interest and inflation rate differentials should be similar for both China and the United States. The inflation rates for China and the U.S. were 7% and 3%, respectively. Using the linear approximation of the international Fisher relation to calculate the inflation differential, his result is:

Using the linear approximation for the international Fisher relation:
r_C – r_US = E (i_C) – E (i_US) = 0.07 – 0.03 = 0.04 or 4.0%