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Dear Sir
Bpp revision kit, page 237, mock exam – question 12, could you please explain this question?
Thank you.
We must have a different edition of the Revision Kit, because there is no question 12 on page 237 of my Kit.
Is it question 12 of mock exam 3, which asks for the length of the working capital cycle (and has the correct answer as 103 days)?
Country X uses the dollar as its currency and country Y uses the dinar.
Country X’s expected inflation rate is 5% per year, compared to 2% per year in country Y. Country Y’s nominal interest rate is 4% per year and the current spot exchange rate between two countries is 1.5000 dinar per$1.
According to the four way equivalence model, which statements is /are true or false?Country X’s nominal interest rate should be 7.06%
The future (expected) spot rate after one year 1 year should be 1.4571 dinar per £1
Country X’s real interest rate should be higher than that of country Y
Many thanks.
Using the Fisher formula, the real interest rate in country Y is 1.04/1.02 – 1 = 0.0196078
Therefore the real interest rate in country X should also be 0.0196078
So using the Fisher formula again, the nominal interest rate in country X will be
(1.096078 x 1.05) – 1 = 0.0706 of 7.06%.
So the first statement is true.Using the formula for future spot rates, the rate in 1 year should be
1.5000 x 1.02/1.05 = 1.4571
So the second statement is true.Real interest rates should be the same in both countries, so the third statement is not true.
Dear John,
would you please explain why real interest rate should be the same in both country? I am happy with the calculations and the calculation also proves this fact that real interest rate are the same in both country. But I can not get the logic behind it! Does it really mean that real interest rate in all countries of the world are the same as each other?!!!(I also watched you lectures but yet did not understand it yet)
thank you
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