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    Purchasing power parity and exchange rates

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    Question 1:

    Starbucks opened its first store in Zagreb, Croatia in October 2010. The price of a tall vanilla latte in Zagreb is 25.70kn. In New York City, the price of a tall vanilla latte is $2.65. The exchange rate between Croatian kunas (kn) and U.S. dollars is kn5.6288/$. According to purchasing power parity, is the Croatian kuna overvalued or undervalued?

    Question 2:

    The Argentine peso was fixed through a currency board at Ps1.00/$ throughout the 1990s. In January 2002 the Argentine peso was floated. On January 29, 2003 it was trading at Ps3.20/$. During that one year period Argentina's inflation rate was 20% on an annualized basis. Inflation in the United States during that same period was 2.2% annualized.

    a. What should have been the exchange rate in January 2003 if PPP held?
    b. By what percentage was the Argentine peso undervalued on an annualized basis?
    c. What were the probable causes of undervaluation?

    Question 3:

    Assume that the export price of a Toyota Corolla from Osaka, Japan is ¥2,150,000. The exchange rate is ¥87.60/$. The forecast rate of inflation in the United States is 2.2% per year and is 0.0% per year in Japan. Use this data to answer the following questions on exchange rate pass-through.

    a. What was the export price for the Corolla at the beginning of the year expressed in U.S. dollars?
    b. Assuming purchasing power parity holds, what should the exchange rate be at the end of the year?
    c. Assuming 100% pass-through of exchange rate, what will be the dollar price of a Corolla at the end of the year?
    d. Assuming 75% pass-through, what will be the dollar price of a Corolla at the end of the year?

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    Solution Summary

    The purchasing power parity and exchange rates are examined.