IFM_IM_ch09 - Chapter 9 Forecasting Exchange Rates Lecture...

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Chapter 9 Forecasting Exchange Rates Lecture Outline Why Firms Forecast Exchange Rates Forecasting Techniques Technical Forecasting Fundamental Forecasting Market-Based Forecasting Mixed Forecasting Forecasting Services Reliance on Forecasting Services Forecast Error Potential Impact of Forecast Errors Measurement of Forecast Error Forecast Accuracy over Time Forecast Accuracy among Currencies Forecast Bias Graphic Evaluation of Forecast Performance Comparison of Forecasting Methods Forecasting under Market Efficiency Using Interval Forecasts Methods of Forecasting Exchange Rate Volatility 131
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132 International Financial Management Chapter Theme This chapter stresses the value of reliable forecasts, but suggests that reliable forecasts can’t always be obtained. Because no single forecast technique has been singled out as superior, various techniques are mentioned. Whatever techniques the MNC chooses, it should monitor performance over time. This chapter illustrates how this evaluation can be accomplished. Topics to Stimulate Class Discussion 1. Which forecast technique would you use if you were hired by an MNC to forecast exchange rates? 2. Do you think there will ever be a published technical forecasting model that you could use in the future to most accurately forecast exchange rates? Why or why not? 3. Recall the theories of purchasing power parity (PPP) and international Fisher effect (IFE) in Chapter 8. If these theories were used to forecast exchange rates, which techniques would they be classified as? Why? 4. Assume there is a regression model that was able to identify the factors which affected exchange rate movements in a recent four-year period. Also, suppose that the sensitivity of the exchange rate’s movements to each factor was precisely quantified. Is there any reason not to expect superior forecasting results from this method in the future? Elaborate. 5. What is the use of detecting a forecast bias? POINT/COUNTER-POINT: Which Exchange Rate Forecast Technique Should MNCs Use? POINT: Use the spot rate to forecast. When a U.S.-based MNC firm conducts financial budgeting, it must estimate the values of its foreign currency cash flows that will be received by the parent. Since it is well documented that firms can not accurately forecast future values, MNCs should use the spot rate for budgeting. Changes in economic conditions are difficult to predict, and the spot rate reflects the best guess of the future spot rate if there are no changes in economic conditions. COUNTER-POINT: Use the forward rate to forecast. The spot rates of some currencies do not represent accurate or even unbiased estimates of the future spot rates. Many currencies of developing countries have generally declined over time. These currencies tend to be in countries that have high inflation rates. If the spot rate had been used for budgeting, the dollar cash flows resulting from cash inflows in these currencies would have been highly overestimated. The expected inflation in a country can be accounted for by using the nominal interest rate. A high
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IFM_IM_ch09 - Chapter 9 Forecasting Exchange Rates Lecture...

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