Assume that the spot rate is €
Assume that the spot rate is €0.8144/$, the 180-day forward rateis €0.7933/$, and the 180-day dollar interest rate is 6 percent peryear. What is the 180-day euro interest rate per year that wouldprevent arbitrage?
The consumer price index for the United States (U.S.) rose fromapproximately 121.4 in 1990 to approximately 199.3 in 2010.
a. How much inflation was there in the U.S. during thetwenty-year period?
b. What is the significance of the consumer price index to amultinational corporation?
If the price level in Canada is C$18,500, the price level inFrance is €13,095, and the spot exchange rate is C$1.25/€, pleaseanswer the following questions:
a. What is the internal purchasing power of the Canadian dollar?(Hint: it may be best to calculate the purchasing power of C$10,000first and divide by the price level of C$18,500 to obtain thenumber of consumption bundles for C$18,500).
b. What is the internal purchasing power of the euro in France?(Hint: it may be best to calculate the purchasing power of €10,000first and divide by the price level of €13,095 to obtain the numberof consumption bundles for €13,095).
c. What is the implied exchange rate of C$/€ that satisfiesabsolute PPP?
d. Is the euro overvalued or undervalued relative to theCanadian dollar? Explain the reasoning for your answer.
Answer:
Question1:
The 180-day euro interest rate per year that would preventarbitrage is arrived as below:
180-Day Euro Interest Rate Per Year =(1/€0.8144/$*(1+6%/2)*€0.7933/$ – 1)*(360/180) =.66%
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Question2:
Part a)
The value of inflation during the 20 year period is calculatedas below:
Inflation during the 20 Year Period = (CPI in2010 – CPI in 1990)/CPI in 1990*100 = (199.3 – 121.4)/121.4*100 =64.17%
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Part b)
Consumer price index provides information on the price changesfor a given basket of goods and services. It can help amultinational corporation to adjust the prices of itsproducts/services to meet the requirements of people/customers inthe host country. Timely changes to pricing can increase purchasingpower of consumers which in turn may increase the demand forcompany’s products/services.
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Question3:
Part a)
The internal purchasing power of the Canadian dollar iscalculated as below:
Internal Purchasing Power of Canadian Dollar =C$10,000/C$18,500 per consumption bundle = 0.5405consumption bundles
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Part b)
The internal purchasing power of the Euro in France isdetermined as follows:
Internal Purchasing Power of Canadian Dollar =€10,000/€13,095 per consumption bundle = 0.7637 consumptionbundles
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Part c)
The implied exchange rate is calculated as below:
Implied Exchange Rate of C$/€ that Satisfies AbsolutePPP = C$18,500/€13,095 = C$1.4128/€
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Part d)
The euro is undervalued relative to the Canadiandollar. It is because the actual exchange rate C$1.25/€ isless than the PPP exchange rate (which is C$1.4128/€) indicatingthat Euro will have to strengthen in value in order to move fromC$1.25/€ to C$1.4128/€.
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