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CHAPTER 8 EXCHANGE RATE FORECASTING CHAPTER OUTLINE I. Measuring Exchange Rate Changes II. Forecasting Needs of the Multinational Company a) Hedging decision b) Working capital management c) Long-term investment analysis d) Long-term financing decision e) Other uses III. Forecasting Floating Exchange Rates a) Currency forecasting and market efficiency b) Fundamental analysis (1) The theory of purchasing power parity (2) Multiple regression analysis c) Technical analysis (1) Charting (2) Mechanical rules d) Market-based forecasts (1) Spot rates (2) Forward rates (3) Interest rates f) The evaluation of exchange forecast performance (1) Empirical evidence (2) Skeptics of the efficient market hypothesis IV. Forecasting Fixed Exchange Rates a) Step one: assessing the balance of payments outlook b) International reserves c) The balance of foreign trade d) Inflation e) Money supply f) Official versus market rates g) Step two: measuring the magnitude of required adjustment h) Generalized application of the PPP theory i) Forward premium or discount j) Free market rate k) Step three: timing of adjustment l) Step four: nature of adjustment m) Corrective policies n) Devaluation o) Why and how central banks intervene in currency markets V. Summary 60
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CHAPTER OBJECTIVE This chapter discusses the value of reliable forecasts, but suggests that reliable forecasts cannot always be obtained. While forecasts use a wide variety of forecasting techniques, most can be classified into three broad categories: fundamental analysis, technical analysis, and market-based forecasts. Whatever forecasting methods multinational companies choose, they should monitor performance over time. This chapter explains how this evaluation can be accomplished. KEY TERMS AND CONCEPTS Efficient market hypothesis holds that (1) spot rates reflect all current information and adjust quickly to new information; (2) it is impossible for any market analyst to consistently "beat the market"; and (3) all currencies are fairly priced. Weak-form efficiency implies that all information contained in past exchange movements is fully reflected in current exchange rates. Semi-strong form efficiency suggests that current exchange rates reflect all publicly available information, thereby making such information useless for forecasting exchange rate movements. Strong form efficiency indicates that current exchange rates reflect all pertinent information, whether publicly available or privately held. Multiple regression forecasting model is a systematic effort at uncovering functional relationships between a set of independent (macroeconomic) variables and a dependent variable namely, the exchange rate. Technical analysis is a currency forecasting technique that uses historical prices or trends. Filter rule suggests that investors buy a currency when it rises more than a given percentage above its recent lowest value (support level) and sell the currency when it falls more than a given percentage below its highest recent value (resistance level).
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