The price of a commodity in New Zealand is NZD
15, whereas the price of the same commodity in
Australia is AUD 9.40. The current exchange rate
of the AUD in terms of NZD is 1.3805
a. Is the law of one price (LOP) satisfied or violated? Explain
and show your work
b. In part a), if the LOP is violated, explain
what will happen? What is the direction of arbitrage and what is
the per unit arbitrage profit?
c. What is the exchange rate compatible with the LOP? Show your
work
d. Based on your answer in part c), is the
Australian dollar (AUD) overvalued or undervalued and by how much?
Explain.
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