Implied Exchange Rate Calculator

Implied Exchange Rate Calculator

(The currency you are starting with)

(The currency you are comparing against)

Provide this to see if the currency is over or undervalued.

Results

Implied Exchange Rate: –

function calculateImpliedRate() { var pLocal = parseFloat(document.getElementById('priceLocal').value); var pForeign = parseFloat(document.getElementById('priceForeign').value); var mRate = parseFloat(document.getElementById('marketRate').value); var resultDiv = document.getElementById('resultContainer'); var rateOutput = document.getElementById('impliedRateOutput'); var analysisDiv = document.getElementById('valuationAnalysis'); if (isNaN(pLocal) || isNaN(pForeign) || pLocal <= 0 || pForeign 0) { var difference = ((impliedRate – mRate) / mRate) * 100; var status = difference > 0 ? "overvalued" : "undervalued"; var color = difference > 0 ? "#d93025" : "#188038"; analysisHtml = "Compared to the market rate of " + mRate.toFixed(4) + ":"; analysisHtml += "The foreign currency is " + Math.abs(difference).toFixed(2) + "% " + status + " based on this asset."; analysisHtml += "This suggests that for the prices to reach equilibrium (Purchasing Power Parity), the exchange rate should move towards " + impliedRate.toFixed(4) + "."; } else { analysisHtml = "The implied rate shows that 1 unit of your base currency is equivalent to " + impliedRate.toFixed(4) + " units of the foreign currency based on the price of the selected item."; } analysisDiv.innerHTML = analysisHtml; resultDiv.scrollIntoView({ behavior: 'smooth' }); }

Understanding the Implied Exchange Rate

The Implied Exchange Rate is a financial metric used to determine what the exchange rate between two currencies "should" be based on the price of an identical good in both countries. This concept is the foundation of the Purchasing Power Parity (PPP) theory, which suggests that in the long run, exchange rates should adjust so that an identical basket of goods costs the same in any two currencies.

How the Calculation Works

The math behind an implied exchange rate is straightforward. You divide the price of an item in the foreign currency by the price of the same item in your local (base) currency:

Implied Rate = Price (Foreign Currency) / Price (Base Currency)

Practical Example: The Big Mac Index

The most famous application of the implied exchange rate is the "Big Mac Index" created by The Economist. It uses the price of a McDonald's Big Mac as the benchmark asset because it is produced to a consistent specification in many countries.

• Scenario:
  Price of a Big Mac in the USA: 5.89 USD
  Price of a Big Mac in Switzerland: 6.50 CHF
  Implied Rate: 6.50 / 5.89 = 1.1036 USD/CHF

If the actual market exchange rate is 0.90 CHF per 1 USD, but the implied rate is 1.10, the calculation suggests the Swiss Franc is significantly overvalued compared to the US Dollar based on the price of a burger.

Why Use This Calculator?

Investors and economists use implied exchange rates for several reasons:

• Currency Valuation: Identifying which currencies are "cheap" or "expensive" relative to their actual purchasing power.
• Arbitrage Opportunities: In stock markets, the implied rate between a dual-listed stock (like a stock listed in both New York and London) can reveal temporary price discrepancies.
• Inflation Tracking: Significant gaps between market rates and implied rates often signal high inflation or trade barriers in a specific country.

Limitations

While useful, implied rates don't account for local taxes, labor costs, transport fees, or trade tariffs. A "Big Mac" might be more expensive in Switzerland not because the currency is overvalued, but because labor and rent are significantly higher there than in the United States.