Exam 6: International Parity Conditions

The assumptions for relative PPP are more rigid than the assumptions for absolute PPP.

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:

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?

The forward rate is calculated from all the following observable data items EXCEPT:

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:

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.

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.

Empirical tests have yielded ________ evidence about market efficiency with a general consensus that developing foreign markets are ________.

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:

The Big Mac is considered a good candidate for the application of the law of one price and measurement of under- or overvaluation of a currency. Develop an argument as to why this is a good idea.

All that is required for a covered interest arbitrage profit is for interest rate parity to not hold.

________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.

If exchange markets were not efficient, it would pay for a firm to spend resources on forecasting exchange rates.

Which of the following is NOT an assumption of market efficiency?

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 ________.

If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates will always be equal to current forward rates.

The Fisher Effect is a familiar economic theory in the domestic market. In words, define the Fisher Effect and explain why you think it is also appropriately applied to international markets.

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

The authors state that empirical tests of purchasing power parity "have, for the most part, not proved PPP to be accurate in predicting future exchange rates." The authors then state that PPP does hold up reasonably well in two situations. What are some reasons why PPP does not accurately predict future exchange rates, and under what conditions might we reasonably expect PPP to hold?

The premium or discount on forward currency exchange rates between any two countries is visually obvious when you plot the interest rates of each country on the same yield curve. The currency of the country with the higher yield curve should be selling at a forward discount.