Exam 6: International Parity Conditions

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?

In their approximate form,PPP,IRP,and forward rates as an unbiased predictor of the future spot rate lead to similar forecasts of the future spot rate.

Some forecasters believe that foreign exchange markets for the major floating currencies are "efficient" and forward exchange rates are unbiased predictors of future spot exchange rates.Explain the rationale of this statement including the assumptions made,the meaning of "efficient" and "unbiased",and the empirical evidence.

The current U.S.dollar-yen spot rate is 125¥/$.If the 90-day forward exchange rate is 127 ¥/$ then the yen is selling at a per annum ________ of ________.

Exchange rate pass-through may be defined as:

A ________ is an exchange rate quoted today for settlement at some time in the future.

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.

Assume the current U.S.dollar-yen spot rate is 90 ¥/$.Further,the current nominal 180-day rate of return in Japan is 1% and 2% in the United States.What is the approximate forward exchange rate for 180 days?

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.

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?

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?

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:

Assume the current U.S.dollar-British spot rate is 0.6993£/$.If the current nominal one-year interest rate in the U.S.is 5% and the comparable rate in Britain is 6%,what is the approximate forward exchange rate for 360 days?

The final component of the equation for the Fisher Effect,(r)(π),where r = the real rate of return and π = the expected rate of inflation,is often dropped from the equation because the number is simply too large for most Western economies.

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

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.

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:

The current U.S.dollar-yen spot rate is ¥125/$.If the 90-day forward exchange rate is ¥127/$ then the yen is at a forward premium.

Explain the logic behind the application of the PPP theory to explain changes in the spot exchange rate.

The authors describe an application of uncovered interest arbitrage (UIA)known as "yen carry trade." Define UIA and describe the example of yen carry trade.Why would an investor engage in the practice of yen carry trade and is there any risk of loss or lesser profit from this investment strategy?