dirk01

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:

A) 0.96 and (-0.04).

B) 1.04 and 0.04.

C) 0.96 and 0.04.

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Using the international Fisher relation:

Exact methodology: (1 + rFC) / (1 + rDC) = (1 + E (iFC)) / (1 + E (iDC))

Linear approximation: rFC – rDC = E (iFC) – E (iDC)

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

dirk01

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:

A) 1.005 and −0.005.

B) 1.005 and 0.005.

C) 0.995 and −0.005.

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Using the international Fisher relation:

Exact methodology: (1 + rFC) / (1 + rDC) = (1 + E(iFC)) / (1 + E (iDC))

Linear approximation: rFC – rDC = E(iFC) – E(iDC)

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

dirk01

Chao Wong, CFA, is the portfolio manager for the China Current Fund in Switzerland. He is concerned with the direction of inflation and its effects on interest rates in China. For comparative purposes, he wanted to use Europe as a benchmark since most of his investor base is in Switzerland. The current spot exchange rate is 9.6246 Chinese yuan per euro. He wants to see if the ratio of interest rates between China 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 Chinese nominal interest rate is 10.20% and the annual inflation rate is 7.00%. According to his calculations, the result of the international Fisher relation is:

A) 1.000.

B) 1.014.

C) 0.986.

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Using the international Fisher relation:

Exact methodology: (1 + rFC) / (1 + rDC) = (1 + E (iFC)) / (1 + E (iDC))

By substituting for the international Fisher relation:

(1 + 0.102) / (1 + 0.1176) = (1 + 0.07) / (1 + 0.085)
1.102 / 1.1176 ≈ 1.07 / 1.085
0.9860 ≈ 0.9862

dirk01

Michael Zotov, CFA, is the economist and portfolio manager of the Zotov Investment Fund. 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. He wants to be sure that the real interest rate, the real cost of money in Poland, has also declined. The Polish nominal interest rate is 12.3%, while inflation holds at 9%. Assuming the international Fisher relation holds, the Polish real interest rate is:

A) 3.03%.

B) 1.03%.

C) 2.93%.

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According to the international Fisher relation:

(1 + Nominal interest rate) = (1 + real interest rate) × (1 + inflation rate)

By substituting, solve for the real interest rate:

(1 + 0.123) = (1 + r) × (1 + 0.09)
(1 + r) = 1.123/1.09
(1 + r) = 1.0303
r = 3.03%

dirk01

Chao Wong, CFA, is the portfolio manager for the China Current Fund. He is concerned with the direction of inflation and its effects on interest rates in China. He wants to compare real interest rates across different countries in Asia to see if real interest rates hold according to the international Fisher relation. First, he needs to compute the real interest rate for China. The Chinese nominal interest rate is 10.2% and inflation is currently pegged at 7%. According to his calculations, the Chinese real interest rate is:

A) 2.99%.

B) 3.50%.

C) 1.03%.

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According to the international Fisher relation:

(1 + Nominal interest rate) = (1 + real interest rate) × (1 + inflation rate)

By substituting, solve for the real interest rate:

(1 + 0.102) = (1 + r) × (1 + 0.07)
(1 + r) = 1.102/1.07
(1 + r) = 1.0299
r = 2.99%

dirk01

The Asian Spec Fund, managed by Jonathan Khamal, CFA, engages in currency speculation for its clients. Khamal believes that there is an opportunity to speculate on the Malaysian Ringgit. He believes that the international Fisher relation holds for most currencies on the assumption that real interest rates are constant among developed and emerging countries, but may not hold for Malaysia. The Malaysian nominal interest rate is 7.6% and the annual inflation rate is 4.5%. According to his calculations, the Malaysian real interest rate is:

A) 2.97%.

B) 3.50%.

C) 3.97%.

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According to the international Fisher relation:

(1 + Nominal interest rate) = (1 + real interest rate) × (1 + inflation rate)

By substituting, solve for the real interest rate:

(1 + 0.076) = (1 + r) × (1 + 0.045)
(1 + r) = 1.076/1.045
(1 + r) = 1.0297
r = 2.97%

dirk01

Jennifer Nance has recently been hired as an analyst at the Central City Bank in the currency trading department. Nance, who recently graduated with a degree in economics, will be working with other analysts to determine if there are profit opportunities in the foreign exchange market.
Nance has the following data available:

	US Dollar ($)	UK Pound (£)	Euro (€)
Expected inflation rate	6.0%	3.0%	7.0%
One-year nominal interest rate	10.0%	6.0%	9.0%

Market Spot Rates
	US Dollar ($)	UK Pound (£)	Euro (€)
US Dollar ($)	$1.0000	$1.6000	$0.8000
UK Pound (£)	0.6250	1.0000	2.0000
Euro (€)	1.2500	0.5000	1.0000

Market 1-year Forward Rates
	US Dollar ($)	UK Pound (£)	Euro (€)
US Dollar ($)	$1.0000	$1.6400	$0.8082
UK Pound (£)	0.6098	1.0000	2.0292
Euro (€)	1.2373	0.4928	1.0000

Using the same data above, Nance wishes to determine the order of the real interest rate levels implied by the Fisher Effect in the United States, the United Kingdom and Europe. What is the order of real interest rate levels, ranked from highest to lowest?

A) United States, Europe, United Kingdom.

B) United Kingdom, United States, Europe.

C) United States, United Kingdom, Europe.

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The Fisher Effect implies that the real interest rate is equal to [(1 + nominal interest rate) / (1 + inflation rate)] − 1.
The implied real rates, ranked in order from highest to lowest, are:
United States: [(1.10) / (1.06)] − 1 = 3.8%.
United Kingdom: [(1.06) / (1.03)] − 1 = 2.9%.
Europe: [(1.09) / (1.07)] − 1 = 1.9%.

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Using the same data above, Nance determines that the highest estimate of the expected $/£ spot rate in one year is implied by:

A) purchasing power parity (PPP).

B) uncovered interest rate parity (IRP).

C) the Fisher effect.

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Uncovered IRP: expected 1 − year spot rate = $1.6000(1.10) / (1.06) − 1 = $1.6604.
PPP: expected 1 − year spot rate = $1.6000(1.06) / (1.03) − 1 = $1.6466.
The Fisher effect does not imply a forecast of the expected future spot rate.

dirk01

If the expected inflation is 100% and the real required rate of return is 6%, the nominal interest rate according to the exact form of the Fisher effect is closest to:

A) 12.0%.

B) 6.0%.

C) 112.0%.

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According to the Fisher effect, the relationship between the nominal interest rate and the real interest rate and the expected inflation rate is (1 + r) = (1 + real r)[1 + E(i)]; therefore, the problem yields 1 + r = (1.06)(2) = 2.12, or r = 112%.

dirk01

George Canyon, CFA, an international trader and analyst with Canyon Trading, wants to use the international Fisher relation to determine his trading strategies for the Chinese yuan. Based on his analysis, the expected inflation rate is 7% and the real interest rate is 3%. In order to determine a price for certain corporate debt Canyon is interested in buying, he will use the exact method of the international Fisher relation. Therefore, the nominal interest rate that he should use is:

A) 4.0%.

B) 10.0%.

C) 10.2%.

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Using the international Fisher relation: (1 + r) = (1 + real r) × (1 + E (i))

Where:
r = nominal interest rate
real r = real interest rate
E (i) = expected inflation

The nominal interest rate is:
(1 + r) = (1 + 0.03) × (1 + 0.07)
(1 + r) = (1.102)
r = 0.102 or 10.2%

dirk01

George Canyon, CFA, an international trader and analyst with Canyon Trading, wants to use the international Fisher relation to determine his trading strategies for the Chinese yuan. Based on his analysis, the expected inflation rate is 7% and the real interest rate is 3%. In order to determine a price for certain corporate debt Canyon is interested in buying, he will use the exact method of the international Fisher relation. Therefore, the nominal interest rate that he should use is:

A) 4.0%.

B) 10.0%.

C) 10.2%.

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Using the international Fisher relation: (1 + r) = (1 + real r) × (1 + E (i))

Where:
r = nominal interest rate
real r = real interest rate
E (i) = expected inflation

The nominal interest rate is:
(1 + r) = (1 + 0.03) × (1 + 0.07)
(1 + r) = (1.102)
r = 0.102 or 10.2%