If the nominal interest rates in the United States and Canada are 8 percent and 12 percent, respectively, the real interest rates are the same, and the real exchange rate is fixed, then the market's expectation about the number of Canadian dollars to be received for a U.S. dollar a year from now will be that it will:
A) decrease by 8 percent.
B) decrease by 4 percent.
C) increase by 4 percent.
D) increase by 5 percent.

Question

Quizplus · Accepted Answer

Given that the nominal interest rates in the US and Canada are 8% and 12% respectively, and the real interest rates are the same in both countries, the difference in nominal interest rates is due to the inflation rate difference. According to the International Fisher Effect, the currency of the country with the higher nominal interest rate (Canada in this case) is expected to depreciate. Therefore, the Canadian dollar is expected to depreciate against the U.S. dollar. The expected depreciation rate is the difference in the nominal interest rates, which is 4% (12% - 8%). Thus, one would expect to receive 4% more Canadian dollars for a U.S. dollar a year from now.

If the Nominal Interest Rates in the United States and Canada