AEM_230_Prob_Set__5_Solution_Key_Solutions

# AEM_230_Prob_Set__5_Solution_Key_Solutions - AEM/ECON 230...

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AEM/ECON 230 Prof. David Lee International Trade and Finance Fall 2007 Problem Set #5 - Solution Key Due November 30, 2007 Problem 1: Big Mac Index (36 pts). The "Big Mac Index" of The Economist magazine has been suggested as a rough approximation to estimating exchange rates and whether a given nation's currency is undervalued or overvalued. The tables below give pricing data from 2007 “Big Mac Index” surveys conducted by The Economist . Using these data, we can derive the implied Purchasing Power Parity (PPP) and evaluate the actual exchange rate against the implied exchange rate. The notion of PPP implies that exchange rates in two countries should adjust towards the rate that equalizes the prices of a sample basket of goods in each country. a) Given the local Big Mac prices in local currency and U.S. dollars, derive 1) the Actual US\$ exchange rate, 2) the implied Purchasing Power Parity exchange rate, and 3) the percent of over- or undervaluation vs. the US\$. Enter your results in the tables. (18 points) [Your answers to this section may vary slightly due to rounding off – no penalty applied for this] Big Mac Price in US\$ Actual US\$ Exchange Rate Implied PPP Under/over valuation against US\$ United States \$ 3.22 \$3.22 -- -- -- 1 Brazil Real 6.40 \$3.01 2.13 1.99 -6.5% 2 Britain Pound 1.99 \$3.90 0.51 0.62 21.1% 3 Canada C\$ 3.63 \$3.08 1.18 1.13 -4.3% 4 China Yuan 11 \$1.41 7.80 3.42 -56.2% 5 Euro area Euro 2.94 \$3.82 0.77 0.91 18.6% 6 Japan Yen 280 \$2.31 121.21 86.96 -28.3% Big Mac Price in US\$ Actual US\$ Exchange Rate Implied PPP Under/over valuation against US\$ United States \$ 3.41 \$3.41 -- -- -- 1 Brazil Real 6.90 \$3.61 1.91 2.02 5.9% 2 Britain Pound 1.99 \$4.01 0.50 0.58 17.6% 3 Canada C\$ 3.88 \$3.68 1.05 1.14 7.9% 4 China Yuan 11 \$1.45 7.59 3.23 -57.5% 5 Euro area Euro 3.06 \$4.17 0.73 0.90 22.3% 6 Japan Yen 280 \$2.29 122.27 82.11 -32.8% Big Mac Price in Local Currency January 31, 2007 July 2, 2007 Big Mac Price in Local Currency

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(b) Which currency was the most undervalued on July 2, 2007? ___Chinese Yuan___ [3 points] (c) Which currency was the most overvalued on July 2, 2007? _______Euro______ [3 points] (d) Based on the Big Mac standard, in which country did Purchasing Power Parity (PPP) most closely hold on July 2, 2007? Briefly explain why.
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## This homework help was uploaded on 02/19/2009 for the course AEM 2300 taught by Professor Lee,d.r. during the Fall '06 term at Cornell.

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AEM_230_Prob_Set__5_Solution_Key_Solutions - AEM/ECON 230...

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