Business Performance
Exercise 3

Question A 1 euro = 1.25$ 1 $ = 110 Yen * 1 euro = 100 Yen. Arbitrage?

Answer:
We can change 1 euro for (110*1.25) = 137.5 Yen.
So we by 1 euro for 100 Yen and sell it for 137.5 Yen, by this making an arbitrage profit of 37.5 Yen.

Question B

Unbiased predictor means that on average the prediction would be precise, however not in 100% of the cases. I do not agree with the claim that there is no good predictor for exchange rates since today’s forward exchange rate for July 1st 2012 will be (on average) the spot exchange rate when we reach that day.
Question C
I think that the big max index is a fun and fast way to identify differences in PPP and estimate how much one currency ii over or underevaluated against the other. However, there are several limitations. First the Indexshould be balanced against the purchasing power\wages in each country, or in other words- against the GDP per capita.
One of the problems with this index is that there are many factors that influence the PPP which differ from country to country - countries have different levels of demand for big mac, different levels of local competition, levels of taxes and duties.
Thus, I think the big mac index may be sufficient between countries with similar levels of the factors mentioned above. This is why even inside US PPP doesn’t hold – we all can agree that in center of Manhattan the prices would be different than in some rural areas in Wisconsin because of higher rental, higher wages, shipping costs etc.

Question D
1.
We are about to compare between Israel and US according to the Big Mac Index, as for July 2011. These are two developed countries with similar fast food culture and trends.
Big Mac price in USD, as for 25th July 2011 : 4.07$ | Actual Big Mac Price in $ | Actual Big Mac Price in Shekel | Implied PPP in $ | actual exchange rate | Over valuation of ILS against the $ | Israel | 4.67 | 15.9 | 15.9\4.07 = 3.91 | 15.9\4.67 = 3.4 | (3.91-3.4)\3.4 = 0.15 |

We can see that according to the Big Mac index, the Shekel is overvalued by 15% over the Dollar. However, we should adjust it to GDP per capital:
US GDP per capita:
US- 48,147$
Israel -31,004$
We can see that the ILS is over valuated and that the GDP in US is 55% higher than in Israel. The adjusted to GDP over valuation of ILS is 43% (the Economist).
2.
PPP usually holds well in very homogeneous environments, often among service providers on the internet. When we purchase services through the internet, we usually avoid shipping costs, fees and taxes. Because of the high competition, the differences in prices are flattened. This is why we can receive translation services or simple design services almost in same prices around the globe.