1) 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. there is not enough information to determine

2) According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but
the actual exchange rate is peso 10.80/$1. Thus, at current exchange rates the peso appears to be
________ by ________.

3) One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the
rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of
Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be
approximately ____________

4) If we set the real effective exchange rate index between the United Kingdom and the United
States equal to 100 in 2005, and find that the U.S. dollar has changed to a value of 91.4, then from
a competitive perspective the U.S. dollar is _____________

5) The government just released international exchange rate statistics and reported that the real
effective exchange rate index for the U.S. dollar vs. the Japanese yen decreased from 105 last year
to 95 currently and is expected to fall still further in the coming year. Other things equal, U.S.
________ to/from Japan think this is good news, and U.S. ________ to/from Japan think this is
bad news.

P1 Hyundai’s Pass-Through. Assume that the export price of a Hyundai Sonata from Seoul,
South Korea, is KRW23,460,000. It exports the car to Malaysia. The exchange rate is 279.48/RM.
The forecast inflation rate in Malaysia is 2.0% per year and in South Korea it is 1.5% per year.
Use these data to answer the following questions on exchange rate pass-through.
a. What was the export price for the Sonata at the beginning of the year expressed in Malaysian
ringgit?
b. Assuming purchasing power parity holds, what should be the exchange rate at the end of the
year?
c. Assuming 100% exchange rate pass-through, what will be the Malaysian ringgit price of a
Sonata at the end of the year?
d. Assuming 60% exchange rate pass-through, what will be the Malaysian ringgit price of a Sonata
at the end of the year?

P2 Casper Landsten—CIA (A). Casper Landsten is a foreign exchange trader for a bank in New
York. He has $1 million (or its Swiss franc equivalent) for a short-term money market investment
and wonders whether he should invest in U.S. dollars for three months or make a CIA investment
in the Swiss franc. He faces the following quotes:
Arbitrage funds available: $1,000,000
Spot exchange rate (SFr/$): 1.2810
3-month forward rate (SFr/$): 1.2740
U.S. dollar 3-month interest rate: 4.800%
Swiss franc 3-month interest rate: 3.200%

P3 Trans-Atlantic Quotes. Separated by more than 3,000 nautical miles and five time zones,
money and foreign exchange markets in both London and New York are very efficient. The
following information has been collected from the respective areas:

a. What do the financial markets suggest for infla- tion in Europe next year?
b. Estimate today’s 1-year forward exchange rate between the dollar and the euro.

P4 Chamonix Rentals. You are planning a ski vacation to Mt. Blanc in Chamonix, France, one
year from now. You are negotiating the rental of a chateau. The chateau’s owner wishes to preserve
his real income against both inflation and exchange rate changes, and so the present weekly rent
of €9,800 (Christmas season) will be adjusted upward or downward for any change in the French
cost of living between now and then. You are basing your budgeting on purchasing power parity
(PPP). French inflation is expected to average 3.5% for the coming year, while U.S. dollar inflation
is expected to be 2.5%. The current spot rate is $1.3620/€. What should you budget as the U.S.
dollar cost of the 1-week rental?
Spot exchange rate ($/€): $1.3620
Expected US inflation for coming year: 2.500%
Expected French inflation for coming year: 3.500%
Current chateau nominal weekly rent (€): 9,800

P5 East Asiatic–Thailand. The East Asiatic Company (EAC), a Danish company with
subsidiaries through- out Asia, has been funding its Bangkok subsidiary primarily with U.S. dollar
debt because of the cost and availability of dollar capital as opposed to Thai baht-denominated (B)
debt. The treasurer of EAC–Thailand is considering a 1-year bank loan for $250,000. The current
spot rate is B32.06/$, and the dollar-based interest is 6.75% for the 1-year period. 1-year loans are
12.00% in baht.
a. Assuming expected inflation rates for the coming year of 4.3% and 1.25% in Thailand and the
United States, respectively, according to purchase power parity, what would be the effective cost
of funds in Thai baht terms?
b. If EAC’s foreign exchange advisers believe strongly that the Thai government wants to push
the value of the baht down against the dollar by 5% over the coming year (to promote its export
competitiveness in dollar markets), what might be the effective cost of funds in baht terms?
c. If EAC could borrow Thai baht at 13% per annum, would this be cheaper than either part (a) or
part (b)?

P6 Clayton Moore’s Money Fund. Clayton Moore is the manager of an international money
market fund managed out of London. Unlike many money funds that guarantee their investors a
near risk-free investment with variable interest earnings, Clayton Moore’s fund is a very
aggressive fund that searches out relatively high-interest earnings around the globe, but at some
risk. The fund is pound-denominated. Clayton is currently evaluating a rather interesting
opportunity in Malaysia. Since the Asian Crisis of 1997, the Malaysian government enforced a
number of currency and capital restrictions to protect and preserve the value of the Malaysian
ringgit. The ringgit was fixed to the U.S. dollar at RM3.80/$ for seven years. In 2005, the
Malaysian government allowed the currency to float against several major currencies. The current
spot rate today is RM3.13485/$. Local currency time deposits of 180-day maturities are earning
8.900% per annum. The London eurocurrency market for pounds is yielding 4.200% per annum
on similar 180-day maturities. The current spot rate on the British pound is $1.5820/£, and the
180-day forward rate is $1.5561/£. What would you recommend Clayton do?