2. 18.

Using the exact international Fisher effect [LO 21.2] From our discussion of the Fisher effect in Chapter 7, we know that the actual relationship between a nominal rate, R, a real rate, r, and an inflation rate, h, can be written as:

1 + r = (1 + R)/(1 + h)

This is the domestic Fisher effect.

1. What is the non-approximate form of the international Fisher effect?

2. Based on your answer in (a), what is the exact form for UIP?

(Hint: Recall the exact form of IRP and use UFR.)

3. What is the exact form for relative PPP? (Hint: Combine your previous two answers.)
4. Recalculate the NPV for the Kihlstrom drill bit project (discussed in Section 21.5) using the exact forms for UIP and the international Fisher effect. Verify that you get precisely the same answer either way.