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International Finance Forecasting Exchange Rates International Finance Forecasting Exchange Rates

International Finance Forecasting Exchange Rates - PowerPoint Presentation

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Uploaded On 2020-08-03

International Finance Forecasting Exchange Rates - PPT Presentation

1 Why Firms Forecast XRs Hedging decisions Hedging payables and receivables Shortterm financing decisions Which currency to borrow in Low rate weakening currency 2 Why Firms Forecast XRs Shortterm investment decisions ID: 796613

error forecast techniques forecasting forecast error forecasting techniques currency xrs term firms realized foreign rates errors mexican peso earnings

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Presentation Transcript

Slide1

International Finance

Forecasting Exchange Rates

1

Slide2

Why Firms Forecast XRs

Hedging decisionsHedging payables and receivablesShort-term financing decisions

Which currency to borrow in

Low rate, weakening currency

2

Slide3

Why Firms Forecast XRs

Short-term investment decisionsWhich currency to park money inHigh rate, strengthening currency

3

Slide4

Why Firms Forecast XRs

Capital budgeting decisionsAnalysis includes currency conversions for future cash flowsMust assume an XR

4

Slide5

Why Firms Forecast XRs

Earnings assessmentsShould foreign subsidiary remit earnings to parent, or reinvest in foreign country?

Remit if foreign currency is expected to depreciate

5

Slide6

Why Firms Forecast XRs

Long-term financing decisionsCurrency of coupon payments for bondsDual currency bonds

Coupon payments in different currency from face value

6

Slide7

Forecasting Techniques

Technical ForecastingUse of historical XR dataLooks for trends

Tends to focus on near-term future

Not very precise

Patterns may disappear

7

Slide8

Forecasting Techniques

Fundamental ForecastingBased on relationships between economic variables and XRsInflation rates

Interest rates

Income levels

Government controls

8

Slide9

Forecasting Techniques

Fundamental ForecastingForecasters study fundamentals of economy to predict economic trendsPlot how past econ events impacted XRs

Use linear regression to forecast

9

Slide10

Forecasting Techniques

Purchasing Power Parity(1 + Π

D

)

=

S

t+1

= 1+

Δ

S

D/F

(1 +

Π

F

) S

t

Inflation expectations can come from TIPS vs.

T-notes

10

Slide11

Forecasting Techniques

Forward RatesMarket-based forecastMust account for bid-ask spread (can be wide

)

11

Slide12

Forecasting Techniques

Example: $/£

Slide13

Forecasting Techniques

Today’s Spot RateExpectations already built into spot rateBest for short-term forecasting

Relies on notion of market efficiency

13

Slide14

Forecasting Techniques

with Mexican Peso

Slide15

Forecast Error

Always will have some errorPotential error is larger forMore volatile currencies

Longer forecast horizon

15

Slide16

How Forecast Error is Affected by Volatility

16

Slide17

Forecast Error

Forecast error can have severe consequences for MNCCan turn positive NPV project into negative NPV projectMNC may choose to hedge

17

Slide18

Forecast Error

Measuring forecast errorAs percentage of realized value

Difference between

Forecasted & Realized

Error =

Value

Value

Realized Value

18

Slide19

Forecast Error Example

British Pound Mexican Peso

1.50 - 1.35

= 10%

.12 - .10

=20%

1.50 .10

19

Forecasted

Value

Realized

Value

British Pound

$1.35

$1.50

Mexican Peso

$.12

$.10

Slide20

Types of Forecast Errors

Inaccurate but unbiasedLow r2

Large but random forecast errors

Biased

Predictable forecast errors

20

Slide21

Forecast Error Example

Slide22

Forecast Error Example