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Lect09-International Financial Markets-VineyChptr15

# Remember usd is term here so its interest rate is for

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Unformatted text preview: nd the foreign country are E(p\$) and E(p£) respectively, then over time, the commodity’s prices are expected to become: \$A 1 [ 1 + E(p\$) ] and £ s [ 1 + E(p£) ] respectively. 34 • Example: PPP & Unbiased Forward Rate concepts 1 + i * f = s 1+ i If the expected inflation rates in Australia and the USA are 3% and 5% respectively, and the forward exchange rate is \$US0.68, use parity concepts to calculate the equilibrium spot exchange rate. (Remember USD is term here, so its interest rate is for i*) 0.68 s = s [ 1.05 / 1.03 ] = \$US 0.6670 35 PPP and McDonalds The Big Mac Index • “Burgernomics” was introduced by The Economist in 1986 as a humerous illustration of PPP • The Big Mac is a homogeneous product that is available all across the world and local franchisees have large say in negotiating imput prices • Examines the relative prices of Big Macs to determine whether a particular currency is under valued or over valued with respect to the US dollar • In 2004, The Economist produced a ‘Tall Latte’ index, where it replaced the Big Mac with a Starbucks Tall Latte. • Also a ‘Coke Map”, where national wealth is measured according to Coca-Cola consumption. 36 \$A3.45 x 0.7739 = \$US2.67 \$3.45 / \$3.22 = 1.07 37 Source www.economist.com/markets/bigmac The Empirical Validity of Purchasing Power Parity • There is evidence for purchasing power parity...
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