Question

please answer both!!! rating will be given, much appreciated

1- Currencies – U.S. dollar foreign-exchange rates. May 5, 2011

Country/currency………….in US$............per US$

British Pound………………1.5347…………0.6516

Norwegian Kroner………...0.1690…………5.9173

Thai Baht…………………..0.0310…………32.250

Suppose a Big Mac costs $3.27 in Boston, and 101 Thai Baht in Thailand. In this circumstance, what can we say is TRUE?

	a.	Purchasing Power Parity does not hold, and Big Macs are relatively expensive in Thailand
	b.	Purchasing Power Parity holds, and Big Macs are relatively expensive in Thailand
	c.	Purchasing Power Parity holds, and Big Macs are relatively cheap in Thailand
	d.	Purchasing Power Parity holds, and Big Macs cost the same in these two cities
	e.	Purchasing Power Parity does not hold, and Big Macs are relatively cheap in Thailand

2- A portfolio is formed with 50% of your money in Stock 1 and 50% of your money in stock 2. Stock 1 has a standard deviation of 0.03, and stock 2 has a standard deviation of 0.075. Which comes closest to the portfolio variance if the covariance between Stock 1 and Stock 2 is -0.005?

	a.	-0.0009
	b.	-0.011
	c.	-0.002
	d.	-0.0002
	e.	-0.005

Answer 1

(1) Option(e) is correct answer, because
Country	In US $	per US $
British Pound	1.5347	0.6516
Norwegian Kroner	0.169	5.9173
Thai Baht	0.031	32.25
Big Mac in Boston is $3.27 but same in Thailand is 101 Thai Baht
The value of big mac in Thailand as per above rate	= $3.27*32.25 Thai Baht
	= 105.46
So, Purchase power parity not hold because, actual value and expected value using exchange rate are not same.
And in Thailand Big mac is cheap. Because actual value is less than expected value using exchange rates.
2. Option (a) is the correct answer.
Standard deviation of portfolio contains 1,2 Stocks: [SD(p)]
=√((W(1)*SD(1))^2+(W(2)*SD(2))^2+2*W(1)*W(2)*Covariance(1,2))
=√((0.5*0.03)^2+(0.5*0.075)^2+2*0.5*0.5*(-0.005))
= - 0.03
Variance of portfolio consists of stocks 1&2:
= SD(p)^2
= (-0.03)^2
= 0.0009