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To buy a six-pack of Diet Coke in Slabovia, you need 50 slabs (the local currency)....

  1. To buy a six-pack of Diet Coke in Slabovia, you need 50 slabs (the local currency). The price of a Diet Coke six-pack in the US is US$10. The current exchange rate between the dollar and the slab is 4 slabs=1 dollar.

Using the methodology of the well-known Diet Coke Index, would you say that the slab is overvalued or undervalued with respect to the US dollar? By how much?

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Answer #1

Let's find the implied exchange rate from the given prices of a six-pack Diet Coke in Slabovia and the US.

Implied exchange rate = 5 slabs/USD or 0.2 USD/slabs

Current exchange rate = 4 slabs/USD or 0.25 USD/slabs

Since the current exchange rate (with slabs as the base currency) is greater than the implied exchange rate, we can say that slabs is overvalued compared to the USD.

Slabs is overvalued by (0.25 - 0.2)/0.2 = 0.25 = 25%

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