INTERNATIONAL FISHER EFFECT International fisher effect is a theory in finance that states that difference in nominal interest rates

between two economies in different countries determines the change of exchange rates between the two currencies. The country which has a lower nominal interest rate will have the value of its currency increase. The estimated change in current exchange rate between any two different currencies is directly proportional to the difference in the nominal interest rates of the two countries. Interest rates are independent of monetary variables in an economy. Therefore, an economy which will have a low interest rate will have low inflation rate and vice a versa. This will make the value of that economy¶s currency to increase over a certain period of time. For example, if we have country P and country Q, country P having an interest rate of 10% and country Q having an interest rate of 5% then country P will have increased 5% rate in the inflation rate compared to country Q This theory is known for the assumption of the uncovered interest parity. International trade has led to characterization and segregation of markets (financial and investment) becoming more liberalized and the movement of financial capital has experienced free flow of capital in major world economies. The movement of financial capital has become expeditious and extremely mobile due to technical and technological innovations, and as a result of this mobility, several currencies and interest rates have been affected adversely. Movement of international financial capital has enabled the international monetary system with it being characterized by many speculations about the performance of major world currencies

The Fisher Effect does predict that real interest rates are in no way to be affected by expected inflation rate changes as it will result to nominal interest rate changes. The Fisher Effect suggests that the nominal interest rate contains only 2 components: y y Expected inflation rate Real rate of interest rate

This does translate to mean that the real rate of interest is the nominal interest rate minus the expected inflation rate. This makes the real rate of interest directly observable. By assuming a

This conclusion is known as the Fisher hypothesis/effect and has been debated for several years in the literature (Fisher. Investors must therefore consider the risks and changes expected to occur in the exchange rate between the home currency and the foreign currency. there is a notable relationship between the inflation of countries. interest rates and exchange rates of the same. The Fisher Effect asserts real interest rates across countries are equalized when nominal interest rate differences are driven by the discrepancies in inflation rates across countries. With the Fisher Effect.direct and specific real rate of return in any given country and observing the nominal interest rate is how the inflation rate of a country can be derived. Simply defined. the higher the inflation rate. the higher the rate of interest and vice versa. . and it¶s important that the two be compared due to fluctuating exchange and interest rates. This brings to the picture the relationship between interest rates and exchange rates. Raising the rate of interest to encourage investment and discourage borrowing by the public goes a long way in controlling the inflation. the Fisher Effect attempts to establish the relationship between interest rates and exchange rates. This is taken to mean that a country with a high rate of inflation will have a high rate of interest. Fisher¶s study provides strong evidence about the one-to-one positive relationship between nominal interest rates and expected inflation which leaves the real interest rates constant over time. Thus. 1930).

. Nominal interest rate differential should not be used to predict future spot rate. This might also indicate money markets are not truly internationalized. currency risks transaction costs taxes and psychological barriers. A low R square indicates that overall performance of model is low. Low Beta values show exchange rate movements react to other factors other than interest rate differential.CONCLUSION The purpose of this value is to predict IFE and test its empirical validities in long run. Applying regression on interest rate differential and exchange rate changes made it possible. There are many factors that prevent capital from freely flowing capital across borders to directly match nominal interest rate differential examples of these risks would be political risks.