Chapter 9 Flashcards
Corporate Functions for which ER forecasts are necessary
Hedging Decisions
ST financing decision (borrowing)
ST investment decision (deposit)
Capital Budgeting (cash flow)
Earning Assessment (reinvest earnings in foreign currency or remit back to parent)
LT financing (issuing bonds to secure LT funds)
MNCS motives for forecasting ER are distinguished whether they enhance MNC´s value
by influencing
a) Cash Flow
b) Cost of Capital
accurate measure of future ER
Technical Forecasting
use of historical data to predict future values
Example - peso
technical factors may change speculative positions as they cause an adjustment in particular currency
they overwhelmed economic news
they trigger sales of dollars
they indicate that dollars has been recently oversold –> triggering purchase of dollars
Limitations of Technical Forecasting
typically focuses on the near future
not very useful when you want to develop corporate policies
model is not consistent over all the periods
useless if the past showed random behaviour (pattern has to exist)
even if model shows to be successful for speculative purposes, it will no longer be useful once another participants starts using it
Fundamental Forecasting
based on economic variables
INF; INT; INC; GC; EXP
e= change in currency spot rate
based on current values of these factors & historical impact on currency´s value
Fundamental Forecasting
Process
a) subjective assessment of variables
b) statistical/ quantitatively measured impact of factors on ER
Fundamental Forecasting
Problems
Regression
regression analysis limitations
a) two little variables - not very accurate/significant
b) two many - multicollinearity
poor forecast of these factors
–> use sensitivity analysis to account for uncertainty
–> use PPP for FA (find future spot rate knowing ER found with PPP formula (inflation rate))
Limitations Fundamental Forecasting
data to measure relave prices is inaccurate
timing of impact of infl. fluctuations´ on changing trade patterns, and thus on ER isn´t known with certainty
barriers to trade can disrupt trade pattern (not according to PPP)
interest diff. can affect ER
Limitation Forecasting
Technique (Methodology process)
accuracy of ER forecast depends on accuracy on influential factors
some important infl. factors can´t be quantified
Coefficients derived from the R.A won´t necessarily remain constant
Market-Based Technique
use fwd. rate as forecast of future So
speculation is what helps to push fwd rate to a level that reflects the general expectation of the future So
fwd rate should move towards the market´s general expectation of the future So
Implication of the IFE & IRP to forecast the fwd rate
IRP –> premium reflects IR D
IFE –> currency value due to IR D ( expected Inflation)
–> fwd. rate captures nominal IR (and thus expected Inflation) it should provides a more accurate forecasts for currencies (spec. in those with high inflation) rather than So
Market-based Theory
counter point
fwd rate
very short term horizon (differential less influential)
IR differential may not even be influential in the LR
foreign & home country IR are similar thus fwd similar to spot
(useless to use fwd)
Forecast Error
(forecasted value - realised)/ realised value
(absolute forecast error as % of realised value) - you need to account for error in relation to size of currency value
Methods of Interval Forecasting ER Volatility
recent exchange volatility level (use volatility of historical ER movements over recent periods)
historical time series of volatilities (pattern o changes in ER volatility over time)
Implied Standard Deviation derived from currency option prices
