Introduction

Exchange rate is the price of one currency in terms of another currency. Exchange rates can be
either fixed or floating. Fixed exchange rates are decided by central banks of a country whereas
floating exchange rates are decided by the mechanism of market demand and supply. Exchange
rates can have what is called a spot rate, or cash value, which is the current market value.
Alternatively, an exchange rate may have a forward value, which is based on expectations for
the currency to rise or fall versus its spot price. Forward rate values may fluctuate due to
changes in expectations for future interest rates in one country versus another. For MNC to
know the future exchange rate to hedge their future demand and to evaluate the foreign
denominated cash flows involved in international transactions. Thus, exchange rate forecasting is
very important to evaluate the benefits and risks attached to the international business
environment. There are lots of way to forecast future exchange rate. They are undertaken by
economists and currency analysts working for portfolio management firms and investment banks
to forecast exchange rate and based on that MNC take forward and future option contract. To do
business in foreign market MNC and foreign investor need to concern about exchange rate risk
associate with the domestic country. The cost of an MNC’s operations and the revenue received
from operations are affected by exchange rates movements. Therefore, an MNC’s forecasts of
exchange rate movements can affect the feasibility of its planned projects and might influence its
managerial decisions. An MNC’s revisions of exchange rate forecasts can change the relative
benefits of alternative proposed operations and may cause the MNC to revise its business
strategies. So it is important to forecast the Exchange rate.

Major Forecasting Techniques

 Technical,
 Fundamental,
 Market-based
 Mixed.
Technical Forecasting
Technical forecasting involves the use of historical exchange rate data to predict future values.
There may be a trend of successive daily exchange rate adjustments in the same direction, which
could lead to a continuation of that trend. Alternatively, there may be some technical indication
that a correction in the exchange rate is likely, which would result in a forecast that the exchange
rate will reverse its direction.

Fundamental 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.

Market-Based 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.

Fundamental Versus Technical Forecasting Technic

Exchange rate forecasters typically use two types of models: technical or fundamental.
A fundamental model forecasts exchange rates based on variables that are believed to be
important determinants of exchange rates. Fundamentals-based technic of exchange rates view as
important things like government monetary and fiscal policy, international trade flows, and
political uncertainty. An expected change in some fundamental variable leads to a current change
in the forecast. A technical trading model uses the past history of exchange rates to predict future
movements. Technical traders are sometimes called chartists because they use charts or diagrams
depicting the time path of an exchange rate to infer changing trends. Finance scholars typically
have taken a dim view of technical analysis, since the ability to predict future price movements
by looking only at the past would bring the concept of efficient markets into question. However,
recent research has led to a more supportive view of technical analysis by some scholars and the
method is widely popular among foreign exchange market participants. Surveys indicate that
nearly 90% of foreign exchange dealers use some sort of technical analysis to form their
expectations of exchange rates. However, the same surveys suggest that technical models are
seen as particularly useful for short-term forecasting, while fundamentals are seen as more
important for predicting long-run changes.
Determinants of Exchange Rates
Numerous factors determine exchange rates. Many of these factors are related to the trading
relationship between the two countries. Remember, exchange rates are relative, and are
expressed as a comparison of the currencies of two countries. The following are some of the
principal determinants of the exchange rate between two countries. Note that these factors are in
no particular order; like many aspects of economics, the relative importance of these factors is
subject to much debate.

Interest Rates impact on Exchange rate

Interest rates, inflation, and exchange rates are all highly correlated. By manipulating interest
rates, central banks exert influence over both inflation and exchange rates, and changing interest
rates impact inflation and currency values. Higher interest rates offer lenders in an economy a
higher return relative to other countries. Therefore, higher interest rates attract foreign capital
and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if
inflation in the country is much higher than in others, or if additional factors serve to drive the
currency down. The opposite relationship exists for decreasing interest rates  – that is, lower
interest rates tend to decrease exchange rates.