Table of Contents
CHAPTER
9
Technical Forecasting
3
Fundamental Forecasting
3
Efficient Market---Based Forecasting
4
Mixed Forecasting
4
Forecast Performance
4
Fixed System Forecasting
5
9
Chapter
I C O N
K E Y
Website Link
Key Point
Exercise
Forecasting Exchange Rates
History repeats itself, but most of the time we have no idea why.
A
firm needs to forecast exchange rates because they can substantially affect the cash
flows; directly through a contractual amount or indirectly via changes in the firm’s
competitive position. Exchange rates also affect discount rates and combined with cash
flows eventually determine the value of the firm.
Techniques to predict exchange rates include:
1. Technical Forecasting
2. Fundamental Forecasting
3. Efficient Market-Based Forecasting
4. Mixed Forecast and Exchange Rate Forecasts
Technical Forecasting (History Repeats Itself)
Technical Forecasting uses historical exchange rate data, including statistical tools, and charts to
extract patterns and trends to predict future exchange rates. Firms make only limited use of
historical or technical forecasting because it usually focuses only on the near future making it
difficult to form a long-term corporate strategy. There is little or no theory involved.
However speculators capitalize on the short term technical forecasting to reap profits from the
day-to-day exchange rate prices. News such as the U.S. dollar has recently been oversold is
technical news that the speculator will use to forecast a fall in the U.S exchange rate.
http://pacific.commerce.ubc.ca/xr/data.html Pacific Exchange Rate Service
Fundamental Forecasting
Fundamental forecasting is based on fundamental relationships between economic variables and
exchange rates. It is a theory-based technique and while good in theory, sometimes it lacks in
performance. These key economic variables from economic theories, sensitivity analyses, and
2
parity conditions (traditional flow model, asset market model, and parity conditions) are then used
to predict the exchange rate.
Efficient Market-Based Forecasting
Efficient Market-Based Forecasting uses the current spot rates (Random Walk Hypothesis,
holding that stock prices follow a random walk pattern and, consequently, historic prices are of no
value in forecasting future prices) or future rates. The current spot rate or future rate holds all the
information we need since the market is so efficient.
An efficient market is a trading market in which the current price reflects all available information
from past prices and volumes. In such a market, past price and volume patterns cannot provide
meaningful predictions of future price movement.
http://risk.ifci.ch/glossary.htm Glossaries of Financial Terms
Mixed Forecasting
No one technique has been found to be superior to another. Therefore MNC’s prefer to use a
combination of forecasting methods. The techniques are assigned weights and tabulated on a
100 percent basis.
http://biz.yahoo.com/ifc Yahoo Business
Evaluation of Forecast Performance
An MNC that predicts exchange rates must monitor its performance over time to determine
whether the forecasting procedure is working.
| Forecasted value – Realized Value|
Absolute Forecast Error (% of realized value) =
Realized Value
Example:
British Pound:
Mexican Peso:
Forecasted Value
Realized Value
$1.35
$ .12
$1.50
$ .10
| $1.35 - $1.50 |
= $.10 or 10% for the British Pound
$1.50
| $ .12 - $.10 |
= $.20 or 20% for the Mexican Peso
$ .10
.
3
Fixed Rate Forecasting
Usually there is little forecasting in a fixed-system since the government fixes the exchange rate.
However once in awhile the government changes the rate and there is a large variation in the
exchange rate.
Exchange Rate Changes
4