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CA Final · Advanced Financial Management · International Financial Management

An Indian multinational uses a dollar discount rate of 10% for a US project. Expected inflation is 6% in India and 2% in the US. If it wishes to discount the project's rupee cash flows, which rupee discount rate is consistent with the dollar rate under the international Fisher relationship?

The consistent rupee rate is about 14.31%. Multiply one plus the dollar rate by the ratio of Indian to US inflation factors, 1.10 × 1.06/1.02 = 1.1431, and subtract one. Simple additions or omitting the US inflation adjustment give incorrect rates.

  1. A16.00%
  2. B14.00%
  3. C14.31%Correct
  4. D16.60%

Explanation

The rupee rate is (1.10 × 1.06/1.02) − 1 = 1.14314 − 1, which is about 14.31%. Adding 10% and 6% gives 16%, and compounding 1.10 × 1.06 without dividing by 1.02 gives 16.6%. Both are wrong because they ignore the US inflation. Subtracting 2% arithmetically gives 14%, which ignores compounding.

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