536-2.2a_note[1] - 536-2.2a_note 11S Topic 2.2 International Parity Conditions(Chapter 7 I Outline A Introduction Inflation B Parity Condition 1 PPP 2

536-2.2a_note[1] - 536-2.2a_note 11S Topic 2.2...

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536-2.2a_note, 11S FIN 536 – SU Page 1 of 7 Topic 2.2 International Parity Conditions (Chapter 7) I.Outline A.Introduction: Inflation B.Parity Condition 1.PPP 2.FE 3.IFE 4.IRP 5.UFH II.Homework Assignment Chapter7End-of-Chapter QuestionEnd-of-Chapter Problem (P)7, 8, 14, 18Exam Sample Problem (ES) 1-9 Supplementary Homework Problem (SH)1-2========================================================= Class Notes I.Link 2: Inflation and Interest Rate – The Fisher Effect (FE) A.Review on Interest rate 1.Different Interest rates Time Line Nominal Rate (INOM) Periodic Rate (IPER) Effective Annual Rate (IEFF) Example: 10% annual compounding Example: 10% semiannual compounding Example: 10% Quarterly compounding
FIN 536 – SU Page 2 of 7 2.Interest Rate Example: An investor receives \$1100 in one year in return for an investment of \$1000 now. What is the nominal rate under the following scenarios? Time Line Nominal Rate (INOM) Periodic Rate (IPER) Effective Annual Rate (IEFF) Annual compounding Semiannual compounding Quarterly compounding B.The nominal interest rate will include two components: 1.A real return rate that increases the purchasing power of the loaned funds 2.A return that offsets the loss of purchasing power due to expected inflation. C.FE Example: Find the real interest rate r (Nominal interest rate) a (real interest rate) π(inflation rate) US 2% 1.5% UK 5% 4.5% D.Exact form E.Approximate form F.