Multinational Business Finance, 14e (Eiteman)
Chapter 6 International Parity Conditions
6.1 Prices and Exchange Rates
1) 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:
A) relative purchasing power parity.
B) interest rate parity.
C) the law of one price.
D) equilibrium.
2) 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?
A) $0.0086/¥
B) ¥124/$
C) $0.0081/¥
D) ¥115.75/$
3) 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:
A) correctly priced.
B) under priced.
C) over priced.
D) There is not enough information to determine if the price is appropriate or not.
4) 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?
A) Peso 8.50/$1
B) Peso 10.8/$1
C) Peso 11.76/$1
D) None of the above
5) 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:
A) overvalued.
B) undervalued.
C) correctly valued.
D) There is not enough information to answer this question.
6) 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 ________.
A) overvalued; approximately 21%
B) overvalued; approximately 27%
C) undervalued; approximately 21%
D) undervalued; approximately 27%
7) 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) £24,682
B) £38,751
C) £10,795
D) £15,721
8) 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:
A) $0.96/C$.
B) $1/C$.
C) $1.04/C$.
D) Relative PPP provides no guide for this type of question.
9) ________ 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.
A) The Fisher Effect
B) The International Fisher Effect
C) Absolute Purchasing Power Parity
D) Relative Purchasing Power Parity
10) Two general conclusions can be made from the empirical tests of purchasing power parity
(PPP):
A) PPP holds up well over the short run but poorly for the long run, and the theory holds better
for countries with relatively low rates of inflation.
B) PPP holds up well over the short run but poorly for the long run, and the theory holds better
for countries with relatively high rates of inflation.
C) PPP holds up well over the long run but poorly for the short run, and the theory holds better
for countries with relatively low rates of inflation.
D) PPP holds up well over the long run but poorly for the short run, and the theory holds better
for countries with relatively high rates of inflation.
11) 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.
A) overvalued
B) over compensating
C) undervalued
D) under compensating
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:
A) overvalued.
B) undervalued.
C) very competitive.
D) There is not enough information to answer this question.
13) 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:
A) overvalued.
B) undervalued.
C) equally valued.
D) There is not enough information to answer this question.
14) 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.
A) importers; exporters
B) importers; importers
C) exporters; exporters
D) exporters; importers
15) Exchange rate pass-through may be defined as:
A) the bid/ask spread on currency exchange rate transactions.
B) the degree to which the prices of imported and exported goods change as a result of exchange
rate changes.
C) the PPP of lesser-developed countries.
D) the practice by Great Britain of maintaining the relative strength of the currencies of the
Commonwealth countries under the current floating exchange rate regime.
16) 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?
A) 92%
B) 33.3%
C) 41.7%
D) 4.1%
17) 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?
A) £22,803
B) £25,581
C) £27,363
D) £55,000
18) 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?
A) 20.0%
B) 15.3%
C) 12.2%
D) 7.2%
19) 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:
A) decline.
B) increase.
C) stay the same.
D) insufficient information
20) If a market basket of goods cost $100 is the US and €70 in France, then the PPP exchange
rate would be $.70/€.
21) The assumptions for relative PPP are more rigid than the assumptions for absolute PPP.
22) Empirical tests prove that PPP is an accurate predictor of future exchange rates.
23) Consider the price elasticity of demand. If a product has price elasticity less than one it is
considered to have relatively elastic demand.
24) 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?
25) 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.
26) Explain the logic behind the application of the PPP theory to explain changes in the spot
exchange rate.
1) ________ states that nominal interest rates in each country are equal to the required real rate
of return plus compensation for expected inflation.
A) Absolute PPP
B) Relative PPP
C) The Law of One Price
D) The Fisher Effect
2) In its approximate form the Fisher effect may be written as ________. Where: i = the nominal
rate of interest, r = the real rate of return and π = the expected rate of inflation.
A) i = (r)(π)
B) i = r + π + (r)(π)
C) i = r + π
D) i = r + 2π
3) Assume a nominal interest rate on one-year U.S. Treasury Bills of 2.60% and a real rate of
interest of 1.00%. Using the Fisher Effect Equation, what is the approximate expected rate of
inflation in the U.S. over the next year?
A) 2.10%
B) 2.05%
C) 1.60%
D) 1.00%
4) Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of
interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation
in the U.S. over the next year?
A) 1.84%
B) 1.80%
C) 1.76%
D) 1.72%
5) The relationship between the percentage change in the spot exchange rate over time and the
differential between comparable interest rates in different national capital markets is known as:
A) absolute PPP.
B) the law of one price.
C) relative PPP.
D) the international Fisher Effect.