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24 July, 22:23

You observe that the inflation rate in the United States is 1.0 percent per year and that T-bills currently yield 1.5 percent annually. Use the approximate international Fisher effect to answer the following questions.

a. What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 5 percent per year?

b. What do you estimate the inflation rate to be in Canada, if short-term Canadian government securities yield 8 percent per year?

c. What do you estimate the inflation rate to be in Taiwan, if short-term Taiwanese government securities yield 10 percent per year?

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  1. 24 July, 22:44
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    a) 4.5%

    b) 7.5%

    c) 9.5%

    Explanation:

    Given:

    USA Inflation rate = 1.0%

    T-bills current yield = 1.5%

    a) What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 5 percent per year?

    To find the inflation rate in Australia, use the formula:

    RUS - hUs = RFC - hFC

    Where,

    RUS = T-bills current yield = 1.5% = 0.015

    hUs = USA Inflation rate = 1.0% = 0.01

    RFC = short-term yield of Australian government securities = 5% = 0.05

    Thus,

    RUS - hUs = RFC - hFC

    0.015 - 0.010 = 0.05 - hFC

    0.005 = 0.05 - hFC

    Solve for hFC:

    hFC = 0.05 - 0.005

    hFC = 0.045 = 4.50%

    Inflation rate in Australia = 4.50%

    b) What do you estimate the inflation rate to be in Canada, if short-term Canadian government securities yield 8 percent per year?

    Use the same formula as in part A.

    RUS - hUs = RFC - hFC

    Here, RFC = 8% = 0.08

    Thus,

    0.015 - 0.010 = 0.08 - hFC

    0.005 = 0.08 - hFC

    Solve for hFC

    hFC = 0.08 - 0.005

    hFC = 0.075 = 7.50%

    Inflation rate in Canada = 7.5%

    c) What do you estimate the inflation rate to be in Taiwan, if short-term Taiwanese government securities yield 10 percent per year?

    Use the same formula as in part A.

    RUS - hUs = RFC - hFC

    Here, RFC = 10% = 0.1

    Thus,

    0.015 - 0.010 = 0.10 - hFC

    0.005 = 0.10 - hFC

    Solve for hFC

    hFC = 0.10 - 0.005

    hFC = 0.095 = 9.50%

    Inflation rate in Taiwan = 9.5%
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