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Global financing and exchange rate mechanisms - Essay Example

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Topic: Big Mac Theory EXECUTIVE BRIEF: Pam Woodall, an economist, derived Big Mac index in 1986 to measure an informal estimate of Purchasing Power Parity between two currencies. It is the best way to fix cost to earn more profit in terms of currency exchange rates…
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Global financing and exchange rate mechanisms
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Global financing and exchange rate mechanisms

Big Mac was specifically under consideration because it was the only chain present in almost every country and have an affordable price, that can be dealt with an average income individual (Kotler & Armstrong, 2009). BIG MAC THEORY: Mc Donald’s best selling product is Big Mac. While hanging out with friends, or for lunch or dinner, people order mouth watering Big Mac with accessories. Big Mac Theory is a theory named to make this product, the most profiting product around the globe. The theory that stabilizes the Big Mac profit is the relationship between currencies, the United States Dollar (USD) with other foreign currencies at current exchange rates. Fed, an economist calls this exchange rate theory a game of achieving with currency rates. Big Mac theory tells us that the original exchange rate that is a nominal exchange rate was adjusted for the ratio of different prices to local prices that allows economists to compare the purchasing power of different currencies (Kotler & Armstrong, 2009). To make it clearer PPP Purchasing Power Parity of foreign currencies is measured by the use of Big Mac Theory. Local currency is used for price comparison and will convert it into USD. The country in which Big Mac price in terms of USD is supposedly be higher, it is considered to have an overvalue in comparison to U.S. dollars. Opposite to this if the estimated price in terms of USD is low then it is an undervalued currency. Globally it is considered to be a consistent price around the globe. This theory is referred as Purchasing Power Parity (Kennedy, 2006). Other then Purchasing Power Parity, many factors are there to put influence on the price of Big Mac. Factors other than PPP are labor cost, rent, and other surcharges, which later are added while fixing the final price but that only affects the local consumers and have no relation with McDonald’s head institution. If the exchange rates are allowed to fluctuate, the currency value will establish and can be factorized efficiently in these variables that allow investors to employ capital inflow efficiently. In short, Big Mac theory is about profits at exchange rates (Kotler & Armstrong, 2009). GLOBAL FINANCING OPERATIONS AND EXCHANGE RATE MECHANISMS: Global financing operations are for those institutions that work or invest on an international level and follow set standard regulations, opposed to institutions who work on regional or national level. To maintain these operations, IMF, World Bank, government agencies and ministries of finance design laws and rules through understanding and economic laws. McDonald’s is an international food chain and running its franchises all around the globe. It follows a law of one price that means that selling price is fixed in one currency and is sold at the same rate in any country at the exchange rate (Kennedy, 2006). Purchasing Power Parity (PPP) explains that purchasing power of Big Mac vary according to the price that comes out at exchange rate. For example if Big Mac is sold at $2.5 in U.S., the rate of Big Mac in U.K will be ?2. It does not include tariff charges or carriers to keep cost neutral (Kotler & Armstrong, 2009). RISK MANAGEMENT: McDonald’s Big Mac is sold every day in different regions in different quantities. It very much depends upon the purchasing power ... Read More
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