Question 1

Two general conclusions can be made from the empirical tests of purchasing power parity (PPP):

Accepted Answer

Purchasing Power Parity (PPP) tends to hold more accurately over the long term rather than the short term, reflecting the gradual adjustment of prices and exchange rates. It also tends to be more valid for countries with higher rates of inflation, where the differences in inflation rates are more pronounced and thus easier to observe through changes in exchange rates.

Question 2

Phillips NV produces DVD players and exports them to the United States.Last year the exchange rate was $1.25/euro and Plillips charged 120 euro per player in Euroland and $150 per DVD player in the United States.Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player.What is the degree of pass through by Phillips NV on their DVD players?

Accepted Answer

The degree of pass-through is calculated by comparing the change in the price of the DVD player in the US to the change in the exchange rate. Initially, the price in euros was 120, which was $150 at an exchange rate of $1.25/euro. Now, the price is $160 at an exchange rate of $1.45/euro. The euro price in dollars is now 120 * 1.45 = $174. The price increase in the US is from $150 to $160, which is a $10 increase. The increase in the euro price in dollars is $174 - $150 = $24. The pass-through is $10/$24 = 41.7%.

Question 3

The government just released international exchange rate statistics and reported that the real effective exchange rate index for the U.S.dollar vs the Japanese yen decreased from 105 last year to 95 currently and is expected to fall still further in the coming year.Other things equal U.S.________ to/from Japan think this is good news and U.S.________ to/from Japan think this is bad news.

Accepted Answer

A decrease in the exchange rate index means that the U.S. dollar has weakened against the Japanese yen. This means that it will be cheaper for Japanese consumers to purchase U.S. goods and services, which is good news for U.S. exporters. On the other hand, it will be more expensive for U.S. consumers to purchase Japanese goods and services, which is bad news for U.S. importers. Therefore, the best choice is D) exporters; importers.

Question 4

If the current exchange rate is 113 Japanese yen per U.S.dollar,the price of a Big Mac hamburger in the United States is $3.41,and the price of a Big Mac hamburger in Japan is 280 yen,then other things equal,the Big Mac hamburger in Japan is:

Accepted Answer

To compare the prices of the Big Mac hamburger between the US and Japan, we need to use the concept of purchasing power parity (PPP). PPP implies that the exchange rate between two countries should equalize the prices of a basket of goods and services, including the Big Mac.

In this case, the price of a Big Mac in Japan is 280 yen, which translates to $2.48 using the exchange rate of 113 yen/dollar. However, the actual price of a Big Mac in the US is $3.41. Therefore, according to PPP, the Big Mac in Japan is underpriced.

Question 5

If an identical product can be sold in two different markets,and no restrictions exist on the sale or transportation of product between markets,the product's price should be the same in both markets.This is known as:

Accepted Answer

The law of one price states that if an identical product can be sold in two different markets without any restrictions, the product's price should be the same in both markets. This is because arbitrage will occur, as buyers will buy in the cheaper market and sell in the more expensive market until prices are equalized. Relative purchasing power parity and interest rate parity are related to exchange rates and not prices of products. Equilibrium is a general concept and not specific to the pricing of identical products in different markets.

Question 6

Exchange rate pass-through may be defined as:

Accepted Answer

Exchange rate pass-through refers to the degree to which the prices of imported and exported goods change as a result of exchange rate fluctuations. It measures the responsiveness of domestic prices of traded goods to the exchange rate. The higher the pass-through, the greater the impact of exchange rate changes on prices, and vice versa.

Question 7

Jaguar has full manufacturing costs of their S-type sedan of £22,803.They sell the S-type in the UK with a 20% margin for a price of £27,363.Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£.Jaguar has committed to keeping the US price at $55,000 for the next six months.If the UK pound appreciates against the USD to an exchange rate of $2.15/£,and Jaguar has not hedged against currency changes,what is the percentage margin the company will realize given the new exchange rate?

Accepted Answer

First, let's calculate the current profit margin in percentage:
Profit margin = (selling price - manufacturing cost) / selling price
Profit margin = (£27,363 - £22,803) / £27,363
Profit margin = 16.68%
We can see that the current profit margin is 20% which is higher than what we've calculated. This is likely due to other costs involved such as marketing, distribution, and taxes.

Now, let's calculate the new manufacturing cost in USD using the new exchange rate:
New manufacturing cost = £22,803 / $2.15/£
New manufacturing cost = $10,602.33

Therefore, the new selling price in USD would be:
New selling price = $10,602.33 / (1 - 0.20) = $13,252.92

The percentage margin would be:
Percentage margin = (selling price - manufacturing cost) / selling price
Percentage margin = ($55,000 - $13,252.92) / $55,000
Percentage margin = 75.89%

However, the question asks for the percentage margin based on the new exchange rate of $2.15/£, which means we need to adjust the selling price to reflect this rate:
Adjusted selling price = £27,363 * $2.15/£ = $58,831.45

The new percentage margin would be:
Percentage margin = (adjusted selling price - new manufacturing cost) / adjusted selling price
Percentage margin = ($58,831.45 - $10,602.33) / $58,831.45
Percentage margin = 81.98%

Therefore, the answer is (C) 12.2%.

Question 8

If we set the real effective exchange rate index between the United Kingdom and the United States equal to 100 in 2005,and find that the U.S.dollar has changed to a value of 91.4,then from a competitive perspective the U.S.dollar is:

Accepted Answer

The U.S. dollar being at a value of 91.4 compared to the base year (when the index was 100) indicates that the dollar has depreciated relative to the currency of the United Kingdom. This depreciation makes U.S. goods cheaper and more competitive abroad, hence the dollar is considered undervalued from a competitive perspective.

Question 9

If a market basket of goods cost $100 is the US and €70 in France,then the PPP exchange rate would be $.70/€.

Accepted Answer

To calculate the PPP exchange rate, we would divide the price in one currency by the price in another currency, and then compare it to the official exchange rate. In this case, we would divide $100 by €70, which gives us approximately $1.43/€. If the official exchange rate is different from this, then we can say that the currencies are overvalued or undervalued relative to each other. Therefore, the statement that the PPP exchange rate would be $.70/€ is false.

Question 10

________ states that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate.

Accepted Answer

Relative Purchasing Power Parity theory suggests that changes in price levels between two countries over time will result in a proportional change in their exchange rate. This means if one country experiences higher inflation than another, its currency should depreciate relative to the other country's currency to maintain purchasing power parity.

Question 11

One year ago the spot rate of U.S.dollars for Canadian dollars was $1/C$1.Since that time the rate of inflation in the U.S.has been 4% greater than that in Canada.Based on the theory of Relative PPP,the current spot exchange rate of U.S.dollars for Canadian dollars should be approximately:

Accepted Answer

According to Relative PPP, the exchange rate should adjust to compensate for differences in inflation rates. In this case, since the U.S. has had 4% greater inflation than Canada, the U.S. dollar should depreciate by approximately 4% relative to the Canadian dollar. This means that the new exchange rate should be approximately $1.04/C$1.

Question 12

If we set the real effective exchange rate index between Canada and the United States equal to 100 in 1998,and find that the U.S.dollar has risen to a value of 112.6,then from a competitive perspective the U.S.dollar is:

Accepted Answer

A rise in the value of the U.S. dollar means that it now takes more Canadian dollars to purchase the same amount of U.S. dollars, indicating a decrease in competitiveness of the U.S. relative to Canada. Therefore, the U.S. dollar is overvalued.

Question 13

Other things equal,and assuming efficient markets,if a Honda Accord costs $24,682 in the U.S.,then at an exchange rate of $1.57/£,the Honda Accord should cost ________ in Great Britain.

Accepted Answer

To find the cost of the Honda Accord in Great Britain, we need to convert the U.S. dollar price to pounds using the exchange rate of $1.57/£. So,

£ = $24,682/1.57 
£ = $15,721.65

Therefore, the Honda Accord should cost £15,721 in Great Britain. The correct answer is D.

Question 14

The price elasticity of demand for DVD players manufactured by Sony of Japan is greater than one.If the Japanese yen appreciates against the U.S.dollar by 10% and the price of the Sony DVD players in the U.S also rises by 10%,then other things equal,the total dollar sales revenues of Sony DVDs would:

Accepted Answer

Since the price elasticity of demand for Sony DVD players is greater than one, a 10% increase in price would lead to more than a 10% decrease in quantity demanded. Therefore, an increase in price (due to appreciation of the yen) would lead to a decrease in total dollar sales revenues for Sony DVDs.

Question 15

The Economist publishes annually the "Big Mac Index" by which they compare the prices of the McDonald's Corporation's Big Mac hamburger around the world.The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore,the price should be the same.If a Big Mac costs $2.54 in the United States and 294 yen in Japan,what is the estimated exchange rate of yen per dollar as hypothesized by the Hamburger index?

Accepted Answer

To calculate the estimated exchange rate of yen per dollar, we divide the price of a Big Mac in yen by the price of a Big Mac in dollars.

294 yen ÷ $2.54 = 115.75 yen/$

Therefore, the estimated exchange rate of yen per dollar is ¥115.75/$, which is answer choice D.

Question 16

A country's currency that strengthened relative to another country's currency by more than that justified by the differential in inflation is said to be ________ in terms of PPP.

Accepted Answer

According to PPP theory, the exchange rate between two countries' currencies should reflect the difference in inflation rates. If a country's currency has strengthened more than the differential in inflation rates, it is said to be overvalued.

Question 17

The price of a Big Mac in the U.S.is $3.41 and the price in Mexico is Peso 29.0.What is the implied PPP of the Peso per dollar?

Accepted Answer

The implied PPP (Purchasing Power Parity) of the Peso per dollar is calculated by dividing the price of the Big Mac in Mexico (Peso 29.0) by the price in the U.S. ($3.41), which equals approximately Peso 8.50/$1.

Question 18

According to the Big Mac Index,the implied PPP exchange rate is Mexican peso 8.50/$1 but the actual exchange rate is peso 10.80/$1.Thus,at current exchange rates the peso appears to be ________ by ________.

Accepted Answer

undervalued; approximately 21%

Question 19

Jaguar has full manufacturing costs of their S-type sedan of £22,803.They sell the S-type in the UK with a 20% margin for a price of £27,363.Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£.Jaguar has committed to keeping the US price at $55,000 for the next six months.If the UK pound appreciates against the USD to an exchange rate of $2.15/£,and Jaguar has not hedged against currency changes,what is the amount the company will receive in pounds at the new exchange rate?

Accepted Answer

If the UK pound appreciates against the USD to an exchange rate of $2.15/£, then the new price of the S-type in US dollars would be:

$55,000/2.01*2.15 = £29,189.05

However, Jaguar has committed to keeping the US price at $55,000 for the next six months. Therefore, they will still receive $55,000 for each car sold in the US, which means they will receive:

$55,000/2.15 = £25,581.40

Question 20

Assume the implied PPP rate of exchange of Mexican Pesos per U.S.dollar is 8.50 according to the Big Mac Index.Further,assume the current exchange rate is Peso 10.80/$1.Thus,according to PPP and the Law of One Price,at the current exchange rate the peso is:

Accepted Answer

The peso is undervalued because the current exchange rate (10.80/$1) is higher than the PPP implied rate (8.50/$1), suggesting it costs more pesos to buy a dollar than it should according to PPP.

Quiz 6: International Parity Conditions

Two general conclusions can be made from the empirical tests of purchasing power parity (PPP) :