question archive These Web Analysis' represent the application of the financial tools and techniques you have been learning
These Web Analysis' represent the application of the financial tools and techniques you have been learning
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These Web Analysis' represent the application of the financial tools and techniques you have been learning. These problems require thorough analysis and interpretation of the findings into operational plans and reports. It represents the way financial managers use this type of quantitative analysis in formulating the operational strategies for their companies. This type of financial analysis is very desirable because it contributes to the decision making process by providing facts that can be solidly supported by quantitative data and analysis.
One of the most famous examples of a violation of absolute purchasing power parity is the Big Mac index calculated by The Economist. This index calculates the dollar price of a McDonald's Big Mac in different countries. You can find the Big Mac index by going to www.economist.com. Using the most recent index, which country has the most expensive Big Macs? Which country has the cheapest Big Macs? Why is the price of a Big Mac not the same in every country?
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Step-by-step explanation
Using the most recent index, which country has the most expensive Big Macs?
- Switzerland has the most expensive Big Macs. It is overvalued by 20.9%. Base price in US is 5.71$. Thus, price in Switzerland is = 5.71 * (1+20.9%) = 6.90$
Which country has the cheapest Big Macs?
1)Taiwan has the most cheapest Big Macs. It is undervalued by 57.2%. Base price in US is 5.71$. Thus, price in Taiwan is = 5.71 * (1- 57.2%) = 2.44 $
Why is the price of a Big Mac not the same in every country?
2)PPP states that the value of basket of goods is same across different countries when compared in common currency
3)If the interest rates are different in 2 countries, the exchange rate between 2 countries changes to make the price of basket of goods same to avoid arbitrage.
4)Thus, the above under valuation and over valuation suggests that the exchange rates are not in equilibrium currently and will change in long run to avoid arbitrage
5)Hence, the price of a Big Mac not the same in every country due to non equilibrium exchange rates
