Inflation, Interest Rates, and Exchange Rates 561Still, the concepts of interest rate and purchasing power parity are critically im-
portant to those engaged in international activities. Companies and investors must an-
ticipate changes in interest rates, inflation, and exchange rates, and they often try to
hedge the risks of adverse movements in these factors. The parity relationships are ex-
tremely useful when anticipating future conditions.What is meant by purchasing power parity? Illustrate it.Inflation, Interest Rates, and Exchange Rates
Relative inflation rates, or the rates of inflation in foreign countries compared with
that in the home country, have many implications for multinational financial deci-
sions. Obviously, relative inflation rates will greatly influence future production costs
at home and abroad. Equally important, inflation has a dominant influence on relative
interest rates and exchange rates. Both of these factors influence decisions by multi-
national corporations for financing their foreign investments, and both have an im-
portant effect on the profitability of foreign investments.Big Mac Prices
Actual $ Local Currency
In Local In Implied Exchange Exchange Under()/Over()
Currency Dollars Rate Based on PPPa Rate 4/17/01 Valuationb(%)
(1) (2) (3) (4) (5)
United Statesc $2.54 2.54 — — —
Argentina Peso2.50 2.50 0.98 1.00 2
Australia A$3.00 1.52 1.18 1.98 40
Britain £1.99 2.85 1.28d 1.43d 12
Canada C$3.33 2.14 1.31 1.56 16
China Yuan9.90 1.20 3.90 8.28 53
Denmark DKr24.75 2.93 9.74 8.46 15
Euro area 2.57 2.27 0.99e 0.88e 11
Hong Kong HK$10.70 1.37 4.21 7.80 46
Japan ¥294 2.38 116 124 6
Malaysia M$4.52 1.19 1.78 3.80 53
Mexico Peso21.9 2.36 8.62 9.29 7
Philippines Peso59.00 1.17 23.2 50.3 54
Russia Ruble35.00 1.21 13.8 28.9 52
Switzerland SFr6.30 3.65 2.48 1.73 44
Notes:
aPurchasing power parity: local price divided by price in the United States.
bAgainst dollar.
cAverage of New York, Chicago, San Francisco, and Atlanta.
dDollars per pound.
eDollars per euro.
Source:McDonald’s.