Purchasing Power Parity: Corporate financial managers must constantly monitor the foreign exchange markets when their firm is operating internationally. The theory of Purchasing Power Parity says that foreign exchange rates will adjust to offset differences in inflation across countries. This theory is based on what economist s call the Law of One Price the price of identical goods must be equal in all countries or markets.
A popular index that tracks the Law of One Price is the Big Mac Index. This index is reported regularly in the Economist magazine.
Review a recent article on the Big Mac Index and answer the following questions.
According to the index, which currencies are overvalued? That is, for which currencies is the exchange rate too high, where a Big Mac is expensive in this country relative to the U.S.?
According to the article, what makes this index a poor measure of PPP?
What is a key factor that can explain why emerging-market currencies are consistently undervalued by this measure?