From our discussion of the Fisher effect in this chapter, we know that the actual relationship between a nominal rate, R, a real rate, r, and an inflation rate, h, can be written as follows:

This is the domestic Fisher effect.

(a) What is the non-approximate form of the international Fisher effect?

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

(c) What is the exact form for relative PPP?

(d) Recalculate the NPV for the Kihlstrom drill bit project.
using the exact forms for the UIP and the international Fisher effect. Verify that you get precisely the same answer either way.

Transcribed Image Text:

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