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# International Finance - Purchasing Power

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You are the treasurer of a U.S. multinational corporation with a subsidiary in Spain and you are concerned about the purchasing power of the Spanish peseta.

a. Your expatriates in Spain tell you that the McDonald's Big Mac costs Pta375. You know that the Big Mac costs \$2.43 in the United States. Given this information, what is the exchange rate at which the law of one price holds between the U.S. dollar and the Spanish peseta? Quote the exchange rate in terms of pesetas per dollar.

b. The actual peseta/dollar exchange rate is Pta144/\$. Is the peseta overvalued or undervalued as measured by the Law of One Price applied to the Big Mac? How much is the overvaluation or undervaluation (in percentage terms)?

c. The actual exchange rate is still Pta144/\$. The general level of inflation, as measured by the consumer price index, is 12 percent in Spain and 4 percent in the United States. If these rates of inflation continue for the next year, what will the exchange rate be if relative purchasing power parity holds?

d. The actual exchange rate is still Pta144/\$. The general level of inflation is still 12 percent in Spain and 4 percent n the United States. Suppose that one you?re from now the exchange rate is Pta 160/\$. In real terms, has the peseta appreciated or depreciated? How much has the real appreciation/depreciation been (in percentage terms)?

#### Solution Preview

You are the treasurer of a U.S. multinational corporation with a subsidiary in Spain and you are concerned about the purchasing power of the Spanish peseta.

a. Your expatriates in Spain tell you that the McDonald's Big Mac costs Pta375. You know that the Big Mac costs \$2.43 in the United States. Given this information, what is the exchange rate at which the law of one price holds between the U.S. dollar and the Spanish peseta? Quote the exchange rate in terms of pesetas per dollar.

Exchange rate is the factor by which the amount of one currency is multiplied to yield an ...

#### Solution Summary

Purchasing power is discussed of the U.S. multinational corporations.

\$2.19