exchange rates forecasting.pptx

7/29/2019 Exchange rates forecasting.pptx

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Quantify transactions exposure

Value foreign projects, to develop international operational

strategies, establish prices for products ,manage working

capital.

Evaluate desirability of investing in foreign equity and bondmarkets.

To help decide whether to hedge the currency risks


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International transactions are usually settled in the near future.

Exchange rate forecasts are necessary to evaluate the foreigndenominated cash flows involved in international transactions.

Exchange rate forecasting is very important to evaluate the benefits

and risks attached to the international business environment.


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Four pure approaches to forecasting foreign exchangerates:

(1) The fundamental approach.

(2) The technical approach.

(3) The market based approach.

(4) The mixed approach.


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Long term forecasting Uses fundamental macroeconomic factors to predict

future exchange rates Based on formal economic models of exchange rate

determination Concerned with multiyear forecast Examines economic relationships and financial data to

arrive at a forecast. Short term horizons : Asset Choice Model

Long term horizons : Parity Models GNP, Consumption, Trade balance, Inflation rates,

Interest rates, Unemployment , Productivity indexes


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Asset Choice:

Examines why one currency might be preferred over others.

Variables include:

Relative interest rates (current and anticipated)

Political/country risk

Essentially, trying to identify why the demand for a currency will

change


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Parity Models

Through these models one attempts to calculate anequilibrium exchange rate in the future.

Analysis built on long standing economic theories ofexchange rate determination.

1.Purchasing Power Parity Model

2.International Fisher Effect


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One of the oldest exchange rate models.

Assumes that exchange rates will change to offset relative

prices levels between countries.

Countries with relatively high rates of inflation will show

currency depreciation Countries with relatively low rates of inflation will

experience currency appreciation

In equilibrium, the amount of depreciation (or appreciation)

will be equal to the inflation differential.


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Assume:

Spot GBP/USD: $1.80

Forecasted UK rate of inflation (annualized) for the next 12 months:

2.5%

Forecasted US rate of inflation (annualized) for the next 12 months:1.0%

PPP Spot GBP/USD Forecast

1 year change in GBP: $1.80 x .015 = 0.027.

1 year spot GBP: $1.80 - .027 = $1.773

6 month GBP: $1.80(0.027/2) = $1.800.0135 = $1.7865


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Assume that exchange rates will change in direct proportion torelative differences in long term interest rates.

Assumes that long term interest rates capture the markets

expectation for inflation.

Countries with relatively high rates of long term interest rates (i.e.,high inflation) will show currency depreciation.

Countries with relatively low rates of long term interest rates (i.e.,

low inflation) will show currency appreciation.

In equilibrium, the amount of depreciation (or appreciation) will be

equal to the long term interest rate differential


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Assume:

Spot USD/JPY = 98.00

Current 1 year Japanese Government Bond rate = 0.5%

Current 1 year U.S. Government Bond rate = 4.5%

Spot USD/JPY Forecast

1 year change in JPY = 98.00 x 0.04 = 3.92

1 year spot JPY = 98.00 - 3.92 = 94.08


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Short term forecasting. Uses only past exchange rate data and other financial data to

predict future exchange rates . Future exchange rate information is present in past trading

behavior

Technical analysis looks for the repetition of specific pricepatterns.

Uses charts and price patterns to forecast future moves in spotexchange rates.Looks for price patterns that have historically signed a future

move.Assume historical relationship will result in similar moves in

the future.


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Chartism

Filter rules

i. X % rules

ii. Moving average Cross over rule


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Chartists - Original Technical analysts

Chartists - graphically record actual trading history of an

exchange rate & then try to infer possible future trends

To identify trends through the use of charts, practitioners must

first findpeaks and troughs in the price series.A peak is the highest value of the exchange rate within a

specified period of time (a local maximum)

A trough is the lowest value the price has taken on within the

same period (a local minimum). A series of peaks and troughs establishes downtrends and up

trends, respectively.


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Support level - any chart formation in which price hastrouble falling below a particular level.

Resistance level - any chart formation in which price

has trouble rising above a particular level.

Support level & Resistance level define trading range.

Breakout - When a trading range is broken, a sudden

rise or fall in prices is expected.

Chartists identifies spurious patterns Chartists dont believe in efficient financial markets.


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Popular method for detecting trends in exchangerates.

It is a trading strategy based on the past history of anasset price.

It provides signals to an investor to buy or sell a

currency.


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Go long in foreign currency after the foreign currencyhas appreciated relative to $ by x % above its support

level.

Go short whenever currency falls x % below resistance

level.

Common x % rules - 1%,2 %.


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Use moving averages of exchange rate.

n-day moving averagesample average of last n

trading days including the current rate.

A (y,z) moving average crossover ruleuses averagesover a short period (y days) and over a long period

(z days).

Go long in the foreign currency when the STMA

crosses the LTMA from below. Common rules - (1,5),(1,20),(5,20).


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Extensively used by forex dealers. Inherent problems in fundamental analysis like picking

right exchange rate model, forecasting modelsfundamental variables, non- availability of all

macroeconomic inputs at frequent intervals , poormeasurements

Forward ratenot an unbiased predictor of future spotrate even in efficient market.

Sufficiently large amount of trading world is usingtechnical analysis, demands and supplies will bebuffeted by these irrational traders.


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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 thatreflect the market expectation of the future exchange

rate.

If no forward markets exists for a particular currency ,nominal interest rates are used


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Refers to the use of a combination of forecastingtechniques.

The actual forecast is a weighted average of the various

forecasts developed.


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3 dimensions to evaluate quality of a forecasts

Accuracy

Forecast error = actual exchange rateforecasted rate

Two measures of accuracy - Mean absolute error and Root

mean squared error

Percentage Correct

Evaluate a forecasting record by finding the % of times

the forecaster was on the correct side of forward rate.

It should be strictly larger than 50 % for the forecasters

services to add value to decision-making process.


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Profitability

Technical forecasters performance is characterized by

relatively small number of successful forecasts in

which large profits are made & a relatively large

number of incorrect predictions in which small losses

are incurred.

Compute profits or losses made based on forecastersadvice & compare those returns to returns onalternative investments that do not require forecasts.

exchange rates forecasting.pptx

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