PPP and Exposure
Solve the following problem:
Layton Co. (a U.S. firm) attempts to determine its economic exposure to movements in the Japanese yen by applying regression analysis to data over the last 36 quarters
SP = b0 + b1e + μ
where SP represents the percentage change in Layton's stock price per quarter, e represents the percentage change in the yen value per quarter, and μ is an error term. Based on the analysis, the b0 coefficient is zero and the b1 coefficient is 0.4 and is statistically significant. Layton believes that the inflation differential has a major effect on the value of the yen (based on purchasing power parity). The inflation in Japan is expected to rise substantially while the U.S. inflation will remain at a low level. Would you expect that Layton's value to be favorably affected, unfavorably ffected, or not affected by its economic exposure over the next quarter? Explain.