Forecasting Exchange Rate Movements

Question 1

What if an economy is importing more than exporting?

Answer 1

Means over time more than the domestic currency is being sold (to pay for imports) than is being bought (as export revenue is coverted into its domestic currency)

Question 2

What can a balance of payments deficit cause?

Answer 2

Weaken the domestic currency over the long-term

Question 3

What do high rates of inflation in a foreign country erode?

Answer 3

The purchasing power of that currency is what a unit of the currency can buy in terms of goods and services

Question 4

What does the fall in purchasing power affect?

Answer 4

A unit of the currency can buy on the currency markets and lead to a fall in value of its currency

Question 5

What does purchasing power parity predict for the exchange rate?

Answer 5

Value of foreign currency depends on the relative purchasing power of each currency in its own country and that spot exchange rates will vary over time according to relative price changes

Question 6

If inflation is relatively high in one coutnry?

Answer 6

Country will over the long-term experience a fall in the value of its currecny

Question 7

What should be done in the long-term for interest rates/

Answer 7

Two countries of similar risk should offer similar rates of return to international investors

Question 8

Offering a similar rate of return to international investors effect on interest rates?

Answer 8

Differences in interest rates should reflect differences in inflation

Question 9

What happens in the short-run for interest rates?

Answer 9

Banks use interest rates to calculate forward exchange rates, this is interest rate parity theory

Question 10

What if interest rates are only different between two countries due to inflation?

Answer 10

Inflation rates can be sued to predict the future spot rate

Long-term interest rates can be used predict the future spot rate

Question 11

What can be seen as an unbiased indicator of expected changes in the spot rate?

Answer 11

Logical to assume that if short-term interest rate differences explain the differences between forward rate and spot rate

Question 12

Basis of interest rate parity theory

Answer 12

Forward rates are calculated by interest rate differences

Question 13

Basis of interest rate parity theory?

Answer 13

High inflation = fall in exchange rate

Question 14

What is a translation risk?

Answer 14

RIsk that the domestic currency value of foreign currency assets falls, or value of freign currency liabilities rise

Question 15

When may difference be written off as a loss in translation risk?

Answer 15

If a change in exchange rate causes an adverse change in domestic currency value of foreign assets and liabilities

Question 16

Is translation risk a cash flow?

Answer 16

No but transaction risk is

Question 17

What is done to manage translation risk?

Answer 17

A company that has assets in a foreign currency can match these assets with liabilities in the same foreign currency

Question 18

How to obtain foreign currency debt finance?

Answer 18

Use a currency swap

Question 19

What is an economic risk?

Answer 19

Long-term movements in exchange rate damage’s company value as NPV of business’ cash flow is diminished by expected exchange rate trends

Question 20

When can domestic companioes be affected by an economic risk?

Answer 20

If a sustained movement in exchange rate benefits an overseas rival

Question 21

How can economic risk be difficult to manage?

Answer 21

Diversify its international operations so it is not overly exposed to a change in a single exchange rate