Lecture Session 9_forecasting Exchange Rates
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Module 2 Session 3 :Forecasting Exchange Rates
Session Overview A. Why Firms Forecast Exchange Rates B. Forecasting Techniques
Session Objectives A. Explain how firms can benefit from forecasting exchange rates B. Describe the common techniques used for forecasting C. Explain how forecasting performance can be evaluated
A. Why Firms Forecast Exchange Rates “Many finance decisions are influenced by exchange rate Projections. The derivatives positions are taken anticipating exchange rate movement”
Hedging Decisions Short-term Financing Decisions Short-term Investment Decisions Capital Budgeting Decisions Earnings Assessments Long-term financing Decisions
B. Forecast Techniques 1. Technical Forecasting Limitations of Technical Forecasting 2. Fundamental Forecasting a. Use of Sensitivity Analysis for Fundamental Forecasting b. Use of PPP for Fundamental Forecasting c. Limitations of Fundamental Forecasting
B. Forecast Techniques 3. Market-Based Forecasting a. Use of the Spot Rate b. Use of the Forward Rate c. Rationale for Using the Forward d. Long-Term Forecasting with the Forward Rates e. Implications of the IFE and IRP for Forecast Using the Forward Rate
B. Forecast Techniques 4. Mixed Forecasting a. Since no one method has been found fool proof, a combination of forecasting techniques is used b. the techniques are assigned a weight that totals 100 points c. more reliable techniques assigned a higher weight
C. Fundamental Forecasting “Based on the fundamental relationship between economic variables and Exchange Rates”
E = f (INF, INT, INC, GC, EXP) “Given the current values of these variable along with their historical impact on a currency value, corporation can develop exchange rate Projection”
D. Simplified Forecasting Model of Pound and Dollar Rates BPt = B0 + B1 INF t – 1 + B2 INT t – 1 + Ut > A set of historical data is used to obtain previous value of BP, INF and INT. > Using the dataset from Regression Analysis will generate the values of the regression Co-efficients and their Signs (B0, B1 and B2) > Assume B0 = .02, B1 = .8, B2 = 1.0. Construct the forecasting model.
D. Forecasted Exchange Value of Pound > To develop forecasted value, assume that the most recent quaterly INF (Inflation Rate Differential) is 5% and INT (Interest Rate Differential) is 7%
> What is the expected change in value for the Pound?
Session Overview A. Why Firms Forecast Exchange Rates B. Forecasting Techniques
Session Objectives A. Explain how firms can benefit from forecasting exchange rates B. Describe the common techniques used for forecasting C. Explain how forecasting performance can be evaluated
A. Why Firms Forecast Exchange Rates “Many finance decisions are influenced by exchange rate Projections. The derivatives positions are taken anticipating exchange rate movement”
Hedging Decisions Short-term Financing Decisions Short-term Investment Decisions Capital Budgeting Decisions Earnings Assessments Long-term financing Decisions
B. Forecast Techniques 1. Technical Forecasting Limitations of Technical Forecasting 2. Fundamental Forecasting a. Use of Sensitivity Analysis for Fundamental Forecasting b. Use of PPP for Fundamental Forecasting c. Limitations of Fundamental Forecasting
B. Forecast Techniques 3. Market-Based Forecasting a. Use of the Spot Rate b. Use of the Forward Rate c. Rationale for Using the Forward d. Long-Term Forecasting with the Forward Rates e. Implications of the IFE and IRP for Forecast Using the Forward Rate
B. Forecast Techniques 4. Mixed Forecasting a. Since no one method has been found fool proof, a combination of forecasting techniques is used b. the techniques are assigned a weight that totals 100 points c. more reliable techniques assigned a higher weight
C. Fundamental Forecasting “Based on the fundamental relationship between economic variables and Exchange Rates”
E = f (INF, INT, INC, GC, EXP) “Given the current values of these variable along with their historical impact on a currency value, corporation can develop exchange rate Projection”
D. Simplified Forecasting Model of Pound and Dollar Rates BPt = B0 + B1 INF t – 1 + B2 INT t – 1 + Ut > A set of historical data is used to obtain previous value of BP, INF and INT. > Using the dataset from Regression Analysis will generate the values of the regression Co-efficients and their Signs (B0, B1 and B2) > Assume B0 = .02, B1 = .8, B2 = 1.0. Construct the forecasting model.
D. Forecasted Exchange Value of Pound > To develop forecasted value, assume that the most recent quaterly INF (Inflation Rate Differential) is 5% and INT (Interest Rate Differential) is 7%
> What is the expected change in value for the Pound?
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