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Hi Mr John,
may you please explain the calculation and logic behind the purchasing power parity formula.
Buryecs based in Eurozone – currency EURO- should be base currency 6%
Wirtonia based in other place- currency USD – Should be overseas currency 3%if the company based in Eurozone , seems euro is base currency, USD should be overseas currency. why in formula overseas country is taken eurozone not wirtonia?
spot exchange rate between the Euro and Wirtonia $ is €0.1430 = $1
In the answer given – 0.143*(1+0.06)/(1+0.03)why not like this – 0.143*(1+0.03)/(1+0.06)
may you please explain this part.
thank you a lot.
It is not where the company is based that determines which is the ‘base’ currency and which is the ‘foreign’ currency.
It is determined by which currency is the exchange rate being quoted against. Here the exchange rate for the € is quoted against the $, Therefore as far as the formula is concerned, $ is treated as the base currency and € is treated as the other currency.
Do watch my free lectures on forecasting future spot rates where I also explain the logic behind PPP.
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