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C H A P T E R 9

C H A P T E R 9. Forecasting Exchange Rates. Chapter Overview. Why Firms Forecast Exchange Rates B. Forecast Techniques C. Market Efficiency and Exchange Rates Forecastability. A. Why Firms Forecast Exchange Rates. A. Why Firms Forecast Exchange Rates. Hedging Decisions

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C H A P T E R 9

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  1. C H A P T E R 9 Forecasting Exchange Rates

  2. Chapter Overview • Why Firms Forecast Exchange Rates B. Forecast Techniques C. Market Efficiency and Exchange Rates Forecastability

  3. A. Why Firms Forecast Exchange Rates

  4. A. Why Firms Forecast Exchange Rates • Hedging Decisions • Short-term Financing Decisions • Short-term Investment Decisions • Capital Budgeting Decisions • Earnings Assessments • Long-term financing Decisions Example: Exchange rate forecast: http://exchangerateforecast.com/ Daily FX News(has news, technical analysis and live rates): http://www.dailyfx.com/

  5. B. Forecast Techniques • Technical Forecasting: It involves the use of historical exchange rate data to predict future values. Example: Euro / Canadian Dollar “The EURCAD remains well within its bearish channel. Until a break of a pivot high, it is dangerous (if not foolish) to go long. The bullish pivot is 14113. The next significant price level on the downside is not until the 2007 low at 13284.”

  6. B. Forecast Techniques Technical analysis: Candle stick - candlestick chart reveals things that are not visible on other charts. It gives comprehensive information about price on the market and thus helps better understand and predict future price moves. To identify candle stick patterns, refer to: http://www.forex-charts-book.com/

  7. B. Forecast Techniques 2. Fundamental Forecasting: It is based on fundamental relationships between economic variables and exchange rates. a. Use of PPP for Fundamental Forecasting. US inflation rate is expected to be 1% over the next year, and Australian inflation rate is expected to be 6%. By PPP, the Australian dollar’s exchange rate should change: ef= Ih-If = 1% - 6%=-5%. If the existing spot rate (St) of Australian dollar is $0.50. The expected spot rate at the end of one year (E(St+1)) : E(St+1) = St * (1+ef) = $0.50 * ( 1-5%) =$0.475.

  8. B. Forecast Techniques 2. Fundamental Forecasting: Focus on key economic variables, which can be found at: http://www.forex-fundamental-analysis.com/ Example: What moves EUD/USD? 1) US Non Farm Payroll — measures new jobs created in States.2) Interest rates — FOMC rate decisions.3) US Trade Balance, European Trade Balance — a proportion between exports and imports in US economy.4) U.S. Current Account 5) US Treasury Inflow Capital (TIC) Data — a measure of how much foreign buying of country's securities takes place. 6) US Gross domestic 7) Federal Open Market Committee (FOMC) Rate Decisions — data about changes in currency rates.8) US Retail Sales — a measure of strength of consumer expenditure. 9) Consumer price index (CPI) — a measure of inflation in Europe. product (GDP) — a measurement of growth in economy.

  9. B. Forecast Techniques 3. Market-Based Forecasting: The process of developing forecasts from market indicators. a. Use of the Forward Rate: a forward rate quoted for a specific date in the future is commonly used as the forecasted spot rate on that future date. Example: Recall forward rate is based on “no arbitrage” by applying CIA. E(e) is expected percentage change in exchange rate. E(e) = p = (F/S)-1. If Australian dollar one year forward rate is $0.63 and the spot rate is $0.60. Then E(e)= p=0.63/0.60-1=5%. This indicates that a forecast for the spot rate in one year is $0.63, a 5% appreciation from current spot rate.

  10. B. Forecast Techniques • Market-Based Forecasting: Note: using foreword rate is convenient and free. But, it is more accurate for a short term horizons than for a long term horizon. Question: What can you predict based on PPP? On IFE? On IPR?

  11. C. Forecasting Services 1. Firms that provide forecasting services: • Business International • Conti Currency • Global Insight:http://www.ihsglobalinsight.com/?gclid=CLjt39zJwaACFSDAsgodvkYkaA

  12. D. Forecasting under market efficiency I: Weak form market efficient hypothesis: The historical and current exchange rate information cannot be used to forecast exchange rate movements because: today’s exchange rates reflect all of the past the current exchange rate information. Semi Strong Form market efficient hypothesis: All public information cannot be used to forecast exchange rate movements because: today’s exchange rates reflect all public information. Strong Form market efficient hypothesis: All public and private information cannot be used to forecast exchange rate movements because: today’s exchange rates reflect all public and private information.

  13. D. Forecasting under market efficiency I: Research found that FOREX market is weak form efficient and semi strong form efficient. This implies: using public information to forecast exchange rate is futile. Question: What about forward rate? Is it a predictor of future exchange rate? Homework: 10. Forecasting with a Forward Rate. Assume that the four‑year annualized interest rate in the United States is 9 percent and the four‑year annualized interest rate in Singapore is 6 percent. Assume interest rate parity holds for a four‑year horizon. Assume that the spot rate of the Singapore dollar is $.60. If the forward rate is used to forecast exchange rates, what will be the forecast for the Singapore dollar’s spot rate in four years? What percentage appreciation or depreciation does this forecast imply over the four‑year period?

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