Answer:
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%
