A friend of yours suggests a get-rich-quick scheme: borrow from the nation with
ID: 2495801 • Letter: A
Question
A friend of yours suggests a get-rich-quick scheme: borrow from the nation with the lower nominal interest rate, invest in the nation with the higher nominal interest rate, and profit from the interest-rate differential. Which of the following statements explains the flaw in your friend’s logic?
A. Nominal exchange rates adjust for the effects of inflation.
B. The scheme would work only if the real interest rates are the same in both nations.
C. The scheme would work only if there is greater inflation in one nation than in the other.
Explanation / Answer
Correct option: A. Nominal exchange rates adjust for the effects of inflation.
Reason: Since nominal interest rates do not account for inflation, they do not present the true picture of the economy. Thus, investing decissions made without taking into account inflation in the economy can be dangerous.