Exchange Rate Forecasting

Presented By:- Nitin KirnapureNishit DholakiaVivek Sethia

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…?

MNCGovernmentsFinancial institutionsBrokers (Facilitators to buyers and sellers)

Why Firms ForecastExchange Rates

MNCs need exchange rate forecasts for their: hedging decisions, short-term financing decisions, short-term investment decisions, capital budgeting decisions, and long-term financing decisions.

Exchange Rate ForecastingFundamental Analysis 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 AnalysisThis 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

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

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.

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

PPP theory predicts that changes in relative prices will result in a change in exchange rates,A country with high inflation should expect its

currency to depreciate against the currency of a country with a lower inflation rate

Inflation occurs when the money supply increases faster than output increases

Purchasing power parity puzzle

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INTEREST RATE AND EXCHANGE RATE

Theory says that interest rates reflect expectations about future exchange rates.Fisher Effect (I = r + l).International Fisher Effect:

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

Evidence suggests that neither PPP nor the International Fisher Effect are good at explaining short term movements in exchange rates

Explanation may be investor psychology and the bandwagon effectStudies suggest they play a major role in short

term movementsHard to predict

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