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I am confused with Fisher equation. Could you please explain it to me.
What is nominal value, real value and inflation rate that are used in Fisher equation.
Interest rate differentials between countries
It’s a way of understanding the difference between a real rate and nominal rate which is due to inflation
1+NR = 1+RR * 1+IR
It’s just that countries with higher expected infl rates will have higher nominal
You just need to be able to understand the formula and be able to calculate either a nominal rate given infl & RR
Or calculate a RR given infl and NRPlease do correct me if I am wrong.
Fisher equation explains the direct relationship between nominal interest and inflation which affect the real interest.
Nominal interest is the interest expected to earn whereas it is the real interest that defines the real return from the investment.
For example if an investment has nominal interest of 10% and inflation in the country is 2% then we can calculate what will be the real return received from this investment after 1 years?
Solution:
(1+i) = (1+r) x (1+inf)
rearrange the equation
(1+r) = (1+10%) / (1+2%)
(1+r) = 4.76%This means that if we invest our money in this 10% return security the we will get the only the real return of 4.76% because the inflation of 2% will directly influence our value of money during one year until the maturity date but don’t you think that this is not really very helpful but has limitations because the inflation fluctuates drastically during the years so many times that we will never get the same calculated return! (please explain?)
The Fisher equation explains the direct relationship between nominal interest and inflation, which affects the real interest. The nominal interest is the interest expected to be earned, while the real interest defines the real return from the investment.
Yes you are right but it is important to note that the Fisher equation has limitations. Inflation fluctuates over time, and the calculated return may not accurately reflect the actual return due to these fluctuations.
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