Question

1. Define the Fisher effect

2. What’s a forward exchange agreement?

Answer 1

1)Ans: Fisher effect says the relation between Real interest rate, nominal interest rate and expected inflation. Fisher says that Nominal Interest rate is the addition of Real Interest rate and Expected Inflation. So the equation can be used to find out any unknown variable, that is either real interest rate or nominal or expected inflation.

International Fisher effect says that real interest rate across globe is same. It means that if one country is offering higher interest rate, then that country's currency will depreciate and when you will convert to your own country's currency, then you will not feel the higher interest rate effect.

2) The main concern of MNCs engaged in cross currency transactions are un-favourable movement of exchange rates. So forwards Exchange Agreement is a OTC derivative that allows parties to book exchange rates before hand. So it hedges the currency exposure that a company posses and helps to build a better balance sheet.