Question

What would be the real rates of return on the same deposit if there was a simultaneous 10% increase in all dollar prices

Answer 1

Answer:

Full question is '1. Calculate the dollar rates of return from a £10,000 deposit in a London bank in a year when the interest rate on pounds is 10 percent and the $/£ exchange rate moves from $1.50/£ to $1.38/£. 2. What would be the real rates of return on the same deposit if there was a simultaneous 10% increase in all dollar prices?"

1. In current period, Dollar price of deposit = £10,000 x ($1.50/£) = $15,000

After 1 year, Pound interest = £10,000 x 10% = £1,000

After 1 year, Pound value of (Deposit + Interest) = £(10,000 + 1,000) = £11,000

After 1 year, Dollar value of (D+I) = £11,000 x ($1.38/£) = $15,180

After one year, Dollar rate of return = ($15,180/$15,000) - 1

After 1 year, Dollar rate of return = 1.012 - 1

After 1 year, Dollar rate of return = 0.012

After 1 year, Dollar rate of return = 1.2%

2. As calculated above, After 1 year, Nominal Dollar rate of return = 1.2%

Note: After 1 year, Real Dollar rate of return = Nominal Dollar rate of return - Inflation Rate

Real Dollar rate of return = 1.2% - 10%

Real Dollar rate of return = -8.8%