1

Canadian
Dollar

= 0.71 USD =

33.38

Philippine
Peso

Purchasing Power Parity

An economic theory that estimates the amount of adjustment needed on the exchange
rate between countries in order for the exchange to be equivalent to each currency's
purchasing power.
The relative version of PPP is calculated as:
Where:
"S" represents exchange rate of currency 1 to currency 2
"P1" represents the cost of good "x" in currency 1
"P2" represents the cost of good "x" in currency 2
BREAKING DOWN 'Purchasing Power Parity - PPP'
In other words, the exchange rate adjusts so that an identical good in two different
countries has the same price when expressed in the same currency.
For example, a chocolate bar that sells for C$1.50 in a Canadian city should cost US$1.00
in a U.S. city when the exchange rate between Canada and the U.S. is 1.50 USD/CDN.
(Both chocolate bars cost US$1.00.)
A simple example would be a litre of Coca-Cola. If it costs 2.3 euros in France and 2.00$
in the United States then the PPP for Coca-Cola between France and the USA is 2.3/2.00,
or 1.15. This means that for every dollar spent on a litre of Coca-Cola in the USA, 1.15
euros would have to be spent in France to obtain the same quantity and quality - or, in
other words, the same volume - of Coca-Cola.

Price level ratio of PPP conversion factor (GDP) to market exchange rate
Purchasing power parity conversion factor is the number of units of a country's currency
required to buy the same amount of goods and services in the domestic market as a U.S.
dollar would buy in the United States. The ratio of PPP conversion factor to market
exchange rate is the result obtained by dividing the PPP conversion factor by the market
exchange rate. The ratio, also referred to as the national price level, makes it possible to
compare the cost of the bundle of goods that make up gross domestic product (GDP)
across countries. It tells how many dollars are needed to buy a dollar's worth of goods in
the country as compared to the United States. PPP conversion factors are based on the
2011 ICP round.

Canada

1996-2000

2001-2005

2006-2010

2011-2015

1.3

1.2

1.2

1.1

Law Of One Price

The theory that the price of a given security, commodity or asset will have the same price
when exchange rates are taken into consideration. The law of one price is another way of
stating the concept of purchasing power parity.
BREAKING DOWN 'Law Of One Price'
The law of one price exists due to arbitrage opportunities. If the price of a security,
commodity or asset is different in two different markets, then an arbitrageur will purchase
the asset in the cheaper market and sell it where prices are higher.
When the purchasing power parity doesn't hold, arbitrage profits will persist until the
price converges across markets.

An economic rule which states that in an efficient market, a security must have a single
price, no matter how that security is created. For example, if an option can be created
using two different sets of underlying securities, then the total price for each would be the
same or else an arbitrage opportunity would exist.

The Law of One Price says that identical goods should sell for the same price in two
separate markets. This assumes no transportation costs and no differential taxes applied
in the two markets.
Economists generally assume that the law of one price can be applied in liquid financial
markets because of the possibility of arbitrage. Unlike in international trade, where it
takes time and effort to move goods physically from one place to another, there are very
little barriers in global financial markets.
For example, an ounce of gold should cost the same on commodity exchanges in
Chicago and London. If the gold costs more on one exchange, then traders would have
incentive to purchase the gold on one exchange and sell it at the other one. They would
do what is called an arbitrage.

The Big Mac Index

THE Big Mac index was invented by The Economist in 1986 as a lighthearted guide to
whether currencies are at their correct level. It is based on the theory of purchasingpower parity (PPP), the notion that in the long run exchange rates should move towards
the rate that would equalise the prices of an identical basket of goods and services (in this
case, a burger) in any two countries. For example, the average price of a Big Mac in

America in January 2016

was $4.93; in China it was
only $2.68 at market
exchange rates. So the
"raw" Big Mac index says
that the yuan was
undervalued by 46% at
that time.
Burgernomics was never
intended as a precise
gauge of currency
misalignment, merely a
tool to make exchangerate theory more
digestible. Yet the Big
Mac index has become a
global standard, included
in several economic
textbooks and the subject
of at least 20 academic
studies. For those who
take their fast food more
seriously, we have also
calculated a gourmet
version of the index.
This adjusted index
addresses the criticism
that you would expect
average burger prices to
be cheaper in poor
countries than in rich ones
because labour costs are
lower. PPP signals where
exchange rates should be
heading in the long run,
as a country like China
gets richer, but it says little
about today's equilibrium rate. The relationship between prices and GDP per person may
be a better guide to the current fair value of a currency. The adjusted index uses the line
of best fit between Big Mac prices and GDP per person for 48 countries (plus the euro
area). The difference between the price predicted by the red line for each country, given
its income per person, and its actual price gives a supersized measure of currency underand over-valuation.

International Monetary Fund (IMF)

The International Monetary Fund (IMF) is an organization of 188 countries, working to
foster global monetary cooperation, secure financial stability, facilitate international trade,
promote high employment and sustainable economic growth, and reduce poverty around
the world.
Created in 1945, the IMF is governed by and accountable to the 188 countries that make
up its near-global membership.
Why the IMF was created and how it works
The IMF, also known as the Fund, was conceived at a UN conference in Bretton Woods,
New Hampshire, United States, in July 1944. The 44 countries at that conference sought
to build a framework for economic cooperation to avoid a repetition of the competitive
devaluations that had contributed to the Great Depression of the 1930s.
The IMF's responsibilities: The IMF's primary purpose is to ensure the stability of the
international monetary systemthe system of exchange rates and international payments
that enables countries (and their citizens) to transact with each other. The Fund's mandate
was updated in 2012 to include all macroeconomic and financial sector issues that bear
on global stability.

The International Monetary Fund (IMF) is an international organization that provides

financial assistance and advice to member countries. This article will discuss the main
functions of the organization, which has become an enduring institution integral to the
creation of financial markets worldwide and to the growth of developing countries.
What Does It Do?
The IMF was born at the end of World War II, out of the Bretton Woods Conference in
1945. It was created out of a need to prevent economic crises like the Great Depression.
With its sister organization, the World Bank, the IMF is the largest public lender of funds
in the world. It is a specialized agency of the United Nations and is run by its 186 member
countries. Membership is open to any country that conducts foreign policy and accepts
the organization's statutes.
The IMF is responsible for the creation and maintenance of the international monetary
system, the system by which international payments among countries take place. It thus
strives to provide a systematic mechanism for foreign exchange transactions in order to
foster investment and promote balanced global economic trade.
To achieve these goals, the IMF focuses and advises on the macroeconomic policies of a
country, which affect its exchange rate and its government's budget, money and credit
management. The IMF will also appraise a country's financial sector and its regulatory
policies, as well as structural policies within the macroeconomy that relate to the labor

market and employment. In addition, as a fund, it may offer financial assistance to nations
in need of correcting balance of payments discrepancies. The IMF is thus entrusted with
nurturing economic growth and maintaining high levels of employment within countries.
DEFINITION of 'International Monetary Fund - IMF'
The International Monetary Fund (IMF) is an international organization created for the
purpose of standardizing global financial relations and exchange rates. The IMF generally
monitors the global economy, and its core goal is to economically strengthen its member
countries. Specifically, the IMF was created with the intention of:
1. Promoting global monetary and exchange stability.
2. Facilitating the expansion and balanced growth of international trade.
3. Assisting in the establishment of a multilateral system of payments for current
transactions.
BREAKING DOWN 'International Monetary Fund - IMF'
Fixed exchange rates, also known as the Bretton Woods system (named after the original
UN conference at which the IMF was conceived), refer to the value of a currency being
tied to the value of another currency, or to gold. The system of fixed exchange rates was
established by the IMF as a way to bolster the global economy after the Great Depression
and World War II. This system was abolished in 1971, and ever since, the IMF has
promoted the system of floating exchange rates, which means that the value of a currency
can change in relation to the value of another. This is the familiar system today. For
example, when the U.S. economy suffers, the dollar's value goes down in relation to that
of, say, the euro of the European Union, and the opposite is also true. The exchange rates
established by the IMF allow countries to better manage economic growth and trade
relations. These exchange rates are set in order to prevent economic collapse, which can
occur with runaway exchange rates, which occurs when the rates continue to rise.
The IMF vs. the World Bank
The IMF works hand-in-hand with the World Bank, and although they are two separate
entities, their interests are aligned, and they were created together. While the IMF
provides only shorter-term loans that are funded by member quotas, the World Bank
focuses on long-term economic solutions and the reduction of poverty and is funded by
both member contributions and bonds. The IMF is more focused on economic policy
solutions, while the World Bank offers assistance in such programs as building necessary
public facilities and preventing disease.