Investment Glossary
Glossary of Investment Terms
Purchasing Power Parity (PPP)
Definition: This theory states that over time, the same products and services in different countries should cost the same, after exchange rates are factored in. McDonald’s Big Macs, sold in more than 120 countries, are a good example. (The Economist publishes a Big Mac Index, which tracks the cost of a Big Mac sandwich across the globe.) PPP is commonly used to gauge currency valuations, as a Big Mac in the U.S., for example, should cost the same as a Big Mac in France. But if the French price is higher after the exchange rate is applied, then the U.S. dollar can be considered undervalued.
The theory only applies to goods and services that can be traded, and not to goods and services that are fixed or local. Also, real-world factors are discounted, as trade restrictions, import duties and taxes can affect prices.
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