Exchange Rate Forecasting

Presented By:- Nitin Kirnapure Nishit Dholakia Vivek Sethia

y What is Exchange Rate .?
Exchange Rate implies how much strong is one currency to another.
For example:An exchange rate of 91 Japnese Yen (JPY, ¥) to the United States Doller (USD, $) means that 91 JPY = 1 USD

Exchange rate forecasts are done through calculation of a currency s value with other currencies over a period of time. While there are various theories that can be used to predict exchange rates, all of them have limitations. No model has been able to establish a monopoly in the forecasting process. Exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another

Exchange Rate Forecast is required by whom ?
y MNC y Governments y Financial institutions y Brokers (Facilitators to buyers and sellers)

Why Firms Forecast Exchange Rates
y MNCs need exchange rate forecasts for their: y hedging decisions, y short-term financing decisions, y short-term investment decisions, y capital budgeting decisions, and y long-term financing decisions.

Exchange Rate Forecasting
Fundamental Analysis y It forecasts exchange rates after considering the factors that give rise to long term cycles. Elementary data, such as GDP, inflation rates, productivity indices, balance of trade and unemployment rate, are taken into account. Denotes true value of currency. (long term investments)

Technical Analysis y This approach is based on the premise that it is investor sentiment that determines changes in the exchange rate and makes predictions by charting out patterns.

PRICE AND EXCHANGE RATE : MODELS 
Random Walk Approach  Uncovered Interest Rate Parity (UIP)  Purchasing Power Parity (PPP)  Law of one price. 

Interest rates.  Investor psychology and Bandwagon effects

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LAW OF ONE PRICE
y In competitive markets free of transportation costs and

trade barriers, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency. For Ex : US/French exchange rate: $1 = .78Eur A jacket selling for $50 in New York should retail for 39.24Eur in Paris (50x.78).

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PURCHASING POWER PARITY
y By comparing the prices of identical products in

different currencies, it should be possible to determine the real or PPP exchange rate - if markets were efficient.
y In relatively efficient markets (few impediments to trade

and investment) then a basket of goods should be roughly equivalent in each country.

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MONEY SUPPLY AND INFLATION
y PPP theory predicts that changes in relative prices will

result in a change in exchange rates,
y A country with high inflation should expect its currency

to depreciate against the currency of a country with a lower inflation rate y Inflation occurs when the money supply increases faster than output increases

y Purchasing power parity puzzle

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INTEREST RATE AND EXCHANGE RATE
y Theory says that interest rates reflect expectations

about future exchange rates.
y Fisher Effect (I = r + l). y International Fisher Effect:
y

For any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between the two countries.

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INVESTOR PSYCHOLOGY AND BANDWAGON EFFECTS
y Evidence suggests that neither PPP nor the

International Fisher Effect are good at explaining short term movements in exchange rates y Explanation may be investor psychology and the bandwagon effect
y Studies suggest they play a major role in short term

movements y Hard to predict

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