If the real interest rate is 5%, the U.S. inflation rate is at 3%, and the inflation rate of the

Running Head: EXCHANGE RATES 1




Exchange Rates


Student’s Name


Institution

, EXCHANGE RATES 2


Exchange Rates


An exchange rate in finance is the rate at which a currency will be exchanged for another

one. It is usually between two or more currencies and is considered as the value of a nation’s

currency in relation to another currency. They are determined in the foreign exchange markets

where different buyers and sellers operate. Within the foreign exchange markets, there are

nominal interest rates, real interest rates and inflations rates (Mandelker, 1976).


Nominal versus Real Interest Rates


Nominal interest rate is the proportion of interest before adjustment for inflation. Real

interest rate is the rate of interest an investor, financier or saver receives after tolerating inflation.

The Fisher effect is a theory proposed by Irving Fisher which states that real interest rates are

autonomous of changes in the fiscal base. He argued that the real interest rate is equivalent to the

nominal interest minus the inflation rate.


Real interest rate=Nominal interest rate-Inflation rate


U.S Nominal Interest


Let the nominal interest be R


5%=R-3%


R=5%+3%


R=8%


The nominal interest rate of U.S is 8%