Essays on Multinational Financial Management, Importance of Computation of PPPs Coursework

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The paper "Multinational Financial Management, Importance of Computation of PPPs" is a perfect example of finance and accounting coursework. PPPs are rates which are used in the conversion of currencies that makes the purchasing power of two currencies of various countries to be equal (Adjasi and Biekpe, 2006). This results when there is an elimination of price differences between the two countries. The simplest definition of PPPs is just a mere price relative that indicates the proportion of prices of domestic goods in various countries. The computation of purchasing power parity ensures there is an accurate estimation of what the exchange rate between two countries would be so that it equates that of the two countries’ currencies (Muellbauer, 2007).

The conversion is done between Singapore and the USA so that to determine the country with high currency value. Importance of computation of PPPs This computation of PPPs is very important in improving the quality of international comparison of purchasing power of money by the use of exchange rates. Due to the fluctuating nature of market exchange rates, the measurement of GDP of two countries that has the same GDP may vary when measured in their own home currencies (Muellbauer, 2007).

It is likely to have a higher GDP in one country in a given year and vice versa. PPPs can be estimated annually using the GDP of the two countries. To achieve this the below formula is used PPP rate x, i= PPP rate X I . (GDP defX, i/GDP def X, b PPP rate U, b . GDP def U, i/GDP def, U,b Where PPPrateX, i = PPP exchange rate of country X for year i PPPrateX, b = PPP exchange rate of country X for the benchmark year PPPrateU, b = PPP exchange rate of the (US) for the benchmark year (equal to 1) GDPdefX, i = GDP deflator of country X for year i GDPdefX, b = GDP deflator of country X for the benchmark year GDPdefU, i = GDP deflator of the US for year i GDPdefU, b = GDP deflator of the US for the benchmark year Computation of PPP from 2011 to 2014 using 2010 as the benchmark period YEAR PPP rate Singapore PPP rate the US GDPdef, Singapore GDP US GDP def Sng/GDP Sing b GDPUSA, I/GDP def US b PPP rate sing 2010 0.7 1 101.2 101.95 1 1 0.7 2011 0.7 1 101.2 103.92 1 1.019323198 0.713526238 2012 0.7 1 102.3 105.82 1.010869565 1.037959784 0.734469369 2013 0.7 1 102.3 107.3 1.010869565 1.052476704 0.744741668 2014 0.7 1 102.5 108.65 1.01284585 1.065718489 0.755585984 The result obtained when purchasing power parity between the currency exchange rate of the USA and Singapore has a slight deviation.

In 2011, the purchasing power parity is not equal to the exchange rate as the ratio between the US and Singapore is not equal. The purchasing power parity between US dollar of 1.0 and 0.755 Singapore pound are the same but not exact (Akinboade, 2006). This is a significant sign that the purchasing power of Singapore gains more purchasing power than the US. For Singapore to buy a single commodity of a product, it has not to spend $0.755 to get the same number of goods in the USA (Makina, 2006).

It is therefore significantly shown that the prices of goods in Singapore are relatively expensive. The same problem is found from 2011 to 2014 as there is an increase in ppps. Year PPP EXR 2011 0.713526238 1.604123. 2012 0.734469369 1.584877 2013 0.744741668 1.564768 2014 0.755585984 1.647701 In relation to the result obtained the currency of Singapore tends to be overvalued against the US dollars (Adjasi and Biekpe, 2006). This is because there are high PPPs as compared to exchange rates. The overvaluation of the Singapore currency is caused by the below factors.

Bibliography

Adjasi, C and Biekpe N (2006), ‘Stock Market Development and Economic Growth: The Case of Selected African Countries’, African Development Review, Vol. 18, No. 1, pp. 144– 61.

Akinboade, O. (2006) The Validity of the Purchasing Power Theory for South Africa: A Cointegration Approach’, African Finance Journal, Vol. 8, No. 2, pp. 1–12.

Makina, D (2006), ‘Mean Reversion and Structural Breaks in Real Exchange Rates. South African Evidence’, Applied Financial Economics, Vol. 16, No. 4, pp. 347–59.

Muellbauer (2007). Review of Monetary Policy in South Africa since 1994’, Journal of African Economies, Vol. 16, pp. 705–44.

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