Question

Part 4 Calculation and analysis 1. If the real rate of return is 3.5% and expected inflation is 5.4%, according to The Fisher Effect model, what's the nominal interest rate? 2. If the price of a Mini Cooper is EUR12,000 in France and spot exchange rate is GBP 1=EUR 1.4002, then (1) According to PPP what should the price of a Mini Cooper in the UK be? (2) If instead the Mini Cooper is sold for £9,500 in the UK, what may happen? Please explain the detailed process. (3) If HM Customs and Excise of the UK levies an import duty of 20% on manufactured goods, does arbitrage still exist? Please explain the detailed process. 3. Suppose an American investor have $1 to invest for one year. He can either invest in the US at i, or convert $ for £ at the spot rate S. (When stated in direct terms ), and then invest in the UK at it. Future spot rate is S2. Please derive the formula for the International Fisher Effect. The derivation must be clear and detailed.

Answer 1

1)

Nominal interest rate (1+Real rate)x(1+Inflation rate)-1 Here, Real rate 3.5% Inflation rate 5.4% 9.09% Nominal interest rate (1+3.5%)x(1+5.49%)-1|

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