Foreign Exchange Market and Skill

Topics: Foreign exchange market, Purchasing power parity, Exchange rate Pages: 33 (4480 words) Published: May 3, 2010
Fundamentals of Multinational Finance, 3e (Moffett)
Chapter 6
International Parity Conditions

6.1
Multiple Choice and True/False Questions

1)
If an identical product can be sold in two different markets, and no restrictions exist on the sale or transportation costs, the product's price should be the same in both markets. This is know as A)

relative purchasing power parity.
B)
interest rate parity.
C)
the law of one price.
D)
equilibrium.
Answer:
C
Topic:
The Law of One Price
Skill:
Recognition

2)
________ states that the spot exchange rate is determined by the relative prices of similar baskets of goods. A)
Absolute purchasing power parity
B)
Relative purchasing power parity
C)
Interest rate parity
D)
The Fisher Effect
Answer:
A
Topic:
PPP
Skill:
Recognition

3)
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)
$0.0081/¥
D)
115.75¥/$
Answer:
D
Topic:
PPP
Skill:
Analytical

4)
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)
not enough information to determine if the price is appropriate or not Answer:
B
Topic:
PPP
Skill:
Analytical

5)
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
Answer:
A
Topic:
PPP
Skill:
Analytical

6)
The implied PPP rate of exchange of Mexican Pesos per U.S. dollar is 8.50 according to the Big Mac Index. The current exchange rate is Peso 10.8/$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)
not enough information to answer this question
Answer:
B
Topic:
PPP
Skill:
Analytical

7)
According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but the actual exchange rate is peso10.80/$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%
Answer:
C
Topic:
PPP
Skill:
Analytical

8)
If a market basket of goods cost $100 is the US and 70 euros in France, then the PPP exchange rate would be $.70/euro. Answer:
FALSE
Topic:
PPP
Skill:
Analytical

9)
If according to the law of one price the current exchange rate of dollars per British pound is $1.75/£, then at an exchange rate of $1.85/£, the dollar is ________. A)
overvalued
B)
undervalued
C)
correctly valued
D)
unknown relative valuation
Answer:
B
Topic:
Law of One Price
Skill:
Analytical

10)
Generally speaking, the theory of absolute purchasing power parity works better for single goods...
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