chapters 9-21 - Chapter 9: Exchange Rate Forecasting 127...

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Chapter 9: Exchange Rate Forecasting 127 This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consen t of the publisher. WHO IS CORRECT? Use InfoTrac or some other search engine to learn more about this issue. Which argument do you support? Offer your own opinion on this issue. ANSWER: To the extent that high expected inflation leads to weakness of a currency, the forward rate should provide a more appropriate forecast. However, for some very short horizons, the inflation expectations may not have much influence. Answers to End of Chapter Questions 1. Probability Distribution of Forecasts. Assume that the following regression model was applied to historical quarterly data: e t = a 0 + a 1 INT t + a 2 INF t-1 + t where e t = percentage change in the exchange rate of the Japanese yen in period t INT t = average real interest rate differential (U.S. interest rate minus Japanese interest rate) over period t INF t-1 = inflation differential (U.S. inflation rate minus Japanese inflation rate) in the previous period a 0 , a 1 , a 2 = regression coefficients t = error term Assume that the regression coefficients were estimated as follows: a 0 = 0.0 a 1 = 0.9 a
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128 International Corporate Finance This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consen t of the publisher. ANSWER: Forecast of Forecast of the Interest Rate Percentage Change Differential in the Japanese Yen Probability 0% .9(0%) + .8(3%) = 2.4% 30% 1% .9(1%) + .8(3%) = 3.3% 60% 2% .9(2%) + .8(3%) = 4.2% 10% 2. 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
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chapters 9-21 - Chapter 9: Exchange Rate Forecasting 127...

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