Question

Starbucks opened its first store in Zagreb, Croatia in October 2010. The price of a tall vanilla latte in Zagreb is kn25.70. In New York, the price of a tall vanilla latte is $2.65. The exchange rate between Croatian kunas (kn) and U.S dollars is kn5.6288/$.

(a) According to purchasing power parity, is the Croatian kuna overvalued or undervalued?
(b) By what percent is the kuna overvalued or undervalued?

Answer 1

a)in the explanation

b)72.29 % overvalued.

Step-by-step explanation:

Answer:

Purchasing Power Parity (PPP):

PPP suggests that law of one price held, it means that real cost of one commodity or service is same in all country.

PPP Process:

Cost of a tall vanilla in Zagreb = kn25.70

Cost of tall vanilla in New York = $2.65

Current Exchange rate = kn5.6288 = 1$

Exchange rate according to PPP = 25.70 /2.65 = 9.698 or kn9.698/$

a. According to purchasing power parity, Croatian Kuna is overvalued as the actual exchange rate is lower than the exchange rate calculated. This difference in exchange rate will raise the arbitrage opportunity.

b. Difference between the two exchange rate = 9.698-5.6288 = 4.0692

Percentage = 4.0692/5.6288 = 72.29 % overvalued.