Question

Assume that the international Fisher effect (IFE) holds between the U.S. and the U.K. The U.S. inflation is expected to be 5%, while British inflation is expected to be 3%. The interest rates offered on pounds are 7% and U.S. interest rates are 7%. What does this say about real interest rates expected by British investors?a. real interest rates expected by British investors are equal to the interest rates expected by U.S. investors.b. real interest rates expected by British investors are 2 percentage points lower than the real interest rates expected by U.S. investors.c. real interest rates expected by British investors are 2 percentage points above the real interest rates expected by U.S. investors.d. IFE doesn't hold in this case because the U.S. inflation is higher than the British inflation, but the interest rates offered in both countries are equal.

Answer 1

Answer:C. Real interest rates expected by British investors are 2 percentage points higher than the real interest rate expected by US investor.

Explanation:

The real interest rate is the market interest rate less the inflation rate.

The inflation rate always reduce the purchasing power of money which is the real measure of the purchasing power of money and not the money face value.