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C9-,*,Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,Part III,Exchange Rate Risk Management,Information on existing and anticipated economic conditions of various countries and on historical exchange rate movements,Information on existing and anticipated,cash flows in,each currency,at each subsidiary,Measuring exposure to exchange rate fluctuations,Forecasting exchange rates,Managing exposure to exchange rate fluctuations,Forecasting Exchange Rates,9,Chapter,South-Western/Thomson Learning 2003,See,c9.xls,for spreadsheets to accompany this chapter.,Chapter Objectives,To explain how firms can benefit from forecasting exchange rates;,To describe the common techniques used for forecasting;and,To explain how forecasting performance can be evaluated.,MNCs need exchange rate forecasts for their:,hedging decisions,short-term financing decisions,short-term investment decisions,capital budgeting decisions,long-term financing decisions,and,earnings assessment.,Why Firms ForecastExchange Rates,Forecasting Techniques,The numerous methods available for forecasting exchange rates can be categorized into four general groups:,technical,fundamental,market-based,and,mixed.,Technical forecasting,involves the use of historical data to predict future values.It includes statistical analysis and time series models.,Speculators may find the models useful for predicting day-to-day movements.,However,since they typically focus on the near future and rarely provide point/range estimates,they are of limited use to MNCs.,Technical Forecasting,Fundamental forecasting,is based on the fundamental relationships between economic variables and exchange rates.,A forecast may arise simply from a subjective assessment of the factors that affect exchange rates.,A forecast may be based on quantitative measurements(with the aid of regression models and sensitivity analysis)too.,Fundamental Forecasting,Known relationships like the PPP can be used for the regression models.However,problems may arise.In the case of PPP:,the timing of the impact of inflation on trade behavior is not known for sure,prices may be measured inaccurately,trade barriers may disrupt the trade patterns that should emerge,and,other influential factors may exist.,Fundamental Forecasting,In general,fundamental forecasting is limited by:,the uncertain timing of the impact of the factors,the need for forecasts for factors with instantaneous impact,the possibility that other relevant factors may be omitted from the model,and,changes in the sensitivity of currency movements to each factor over time.,Fundamental Forecasting,Market-based forecasting,involves developing forecasts from market indicators.,Usually,either the spot rate or the forward rate is used,since speculation should push the rates to the level that reflect the market expectation of the future exchange rate.,Market-Based Forecasting,Since forward contracts have low trading volumes and are not widely quoted,the interest rates on risk-free instruments can be used to determine what the forward rates should be according to IRP for long-term forecasting.,Market-Based Forecasting,Mixed Forecasting,Mixed forecasting,refers to the use of a combination of forecasting techniques.,The actual forecast is a weighted average of the various forecasts developed.,Visit :/yardeni for reviews of international political and economic events and their presumed global impact.The site also presents economic and political analyses of major economies.,Country outlooks and exchange rate forecasts can also be found at ifc/.,Online Application,Forecasting Services,The corporate need to forecast currency values has prompted some consulting firms and investment banks to offer forecasting services.,Advice on hedging and international cash management,and assessment of the firms exposure to exchange rate risk,may be provided too.,One way to determine whether a forecasting service is valuable is to compare the accuracy of its forecasts with the accuracy of publicly available and free forecasts.,Forecasting Services,Evaluation of Forecast Performance,An MNC that forecasts exchange rates should monitor its performance over time to determine whether its forecasting procedure is satisfactory.,The MNC may also want to compare the various forecasting methods.,Evaluation of Forecast Performance,One measure of forecast performance is the,absolute forecast error as a percentage of the realized value,:,|forecasted value realized value|,realized value,Over time,MNCs are likely to have more confidence in their forecasts when they know the mean error for their past forecasts.,Evaluation of Forecast Performance,Using the Forward Rate as a Forecast for the British Pound,Absolute Forecast Error($),Evaluation of Forecast Performance,The ability to forecast currency values may vary with the currency of concern.,In particular,the value of a less volatile currency is likely to be forecasted more accurately
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