The nation of F has a unit of currency called the F. In the coming year in F, inflation is expected to be huge, 100%. Canada’s expected inflation rate for the same year is 14%. An investor in Canada can make an interest rate of 18%.

What must be the interest rate in F to be equivalent to the rate in Canada?

References

Hlynka, Myron. "University of Windsor Old Tests 62-392 Theory of Interest". web2.uwindsor.ca. Retrieved November 23, 2023.

Solution: D

We want the real rates in both countries to be the same. For Canada, [math]i=.18, r=.14[/math]. Thus,

[[math]] i_{\text {real }}=\frac{i-r}{1+r}=\frac{.18-.14}{1+.14} [[/math]]

For [math]\mathrm{F}[/math], we want the same real interest rate and [math]r=1.0[/math]. We need to find [math]i[/math] for F. Thus

[[math]] \frac{.18-.14}{1+.14}=\frac{i-r}{1+r}=\frac{i-1}{1+1} [[/math]]

Solving for [math]i[/math] gives [math]i=1.070175=107.0175 \%[/math].

References

Hlynka, Myron. "University of Windsor Old Tests 62-392 Theory of Interest". web2.uwindsor.ca. Retrieved November 23, 2023.