Suppose, we are given the following information: Nominal Interest Rates in Unite

Question

Suppose, we are given the following information:

Nominal Interest Rates in United States                       = 4%

Nominal Interest Rates in Germany                              = 6%

Current Exchange Rate: €1 = $2

Which currency should appreciate and which currency should decline?

By how much foreign currency (euro) will change?

What will be the anticipated value of euro in one year given the nominal interest rates as per International Fisher Effect (IFE)?

Suppose, the exchange rate is fixed and does not change, which currency will appreciate or depreciate in real terms? Which country will attract investment?

Explanation / Answer

1. A currency with lower interest rates will trade at a forward premium in relation to a currency with a higher interest rate.

Calculaiotn Formula

so in that above case USD should appreciate and € (germany) should be Decline.

2. Euro will chnage & depreciate due to higher interest rate of country and the change amount in % term is 2% and value term .04.

3. €1 = 2*(1+.04)/1.06

         = 1.96

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