NEF3201 Engineering Management Week 9 Tutorial Exercises Question 1: An investor
ID: 1711834 • Letter: N
Question
NEF3201 Engineering Management Week 9 Tutorial Exercises Question 1: An investor lives near to one of his country's borders. In Country A (where he lives), an 8% interest rate is offered from banks, and the inflation rate is 3%. In Country B, has an inflation rate of 23% and their banks offer 26% interest rate for deposits. a) What is the real or effective interest rate that this investor gets when investing in his country (A)? b) This Investor believes that the currency of Country B will not change in its value relative to the value of currency in Country A during this year. In which country would he get a larger effectivel/combined interest rate? Suppose he invests in a bank in Country B, and that his earlier prediction was wrong. The currency of Country B was devaluated 20% with respect to the exchange value of Country A's currency. What is the real-effective interest?Explanation / Answer
(a) Interest rate in country A = 8%, inflation = 3%, so the effective interest rate = 8-3 =5 %
(b) In country B, Interest rate = 26%, Inflation = 23%, so effective interest rate = 26-23 = 3%,
However the effective ineterst is lower in country B, but as its value with respect to the currency of country A does not change, He will get higher returns by investing in country B and then converting the returns into currency of country A.
This way he gets 26% - 8% = 22% higher interst rate as compared to when investing in country A currency.
(c) Earlier he got 22% higher returns, but as currency of country B is devalued by 20%, his net profit would be decreased to only 22-20 = 2% greater than what he would get in country A.
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