FOREIGN EXCHANGE RISK

MANAGEMENT

Assignment 1

1.Plot the past monthly exchange rate changes against the differential inflation rates
between the currencies of your preference and the US dollar for the last ten years
(September 2001 September 2011).

Date | HUF/USD | PLN/USD | PLN/HUF | HUF/USD diferrential | PLN/USD differential |

sep.01 | 281,03 | 4,212 | 66,7213 | 0,1676 | 1,2387 |
oct.01 | 281,58 | 4,1259 | 68,2469 | 0,1957 | -2,0442 |
nov.01 | 283,11 | 4,0893 | 69,2319 | 0,5434 | -0,8871 |
dec.01 | 276,98 | 4,0153 | 68,9811 | -2,1652 | -1,8096 |
jan.02 | 275,93 | 4,0688 | 67,8161 | -0,3791 | 1,3324 |
feb.02 | 279,47 | 4,1873 | 66,7423 | 1,2829 | 2,9124 |
mar.02 | 278,91 | 4,1339 | 67,4690 | -0,2004 | -1,2753 |
apr.02 | 273,35 | 4,0566 | 67,3840 | -1,9935 | -1,8699 |
may.02 | 265,46 | 4,0403 | 65,7030 | -2,8864 | -0,4018 |
jun.02 | 254,04 | 4,0225 | 63,1548 | -4,3020 | -0,4406 |
jul.02 | 248,21 | 4,1248 | 60,1750 | -2,2949 | 2,5432 |
aug.02 | 250,67 | 4,1746 | 60,0465 | 0,9911 | 1,2073 |
sep.02 | 248,34 | 4,1506 | 59,8323 | -0,9295 | -0,5749 |
oct.02 | 247,83 | 4,1173 | 60,1924 | -0,2054 | -0,8023 |
nov.02 | 237,91 | 3,9537 | 60,1740 | -4,0027 | -3,9735 |
dec.02 | 231,68 | 3,9097 | 59,2577 | -2,6186 | -1,1129 |
jan.03 | 226,53 | 3,8315 | 59,1231 | -2,2229 | -2,0002 |

feb.03 | 227,12 | 3,8674 | 58,7268 | 0,2605 | 0,9370 |

mar.03 | 227,47 | 4,0157 | 56,6452 | 0,1541 | 3,8346 |
apr.03 | 225,86 | 3,9488 | 57,1971 | -0,7078 | -1,6660 |
may.03 | 212,51 | 3,746 | 56,7298 | -5,9107 | -5,1357 |
jun.03 | 224,21 | 3,8046 | 58,9313 | 5,5056 | 1,5643 |
jul.03 | 231,96 | 3,8983 | 59,5029 | 3,4566 | 2,4628 |
aug.03 | 232,32 | 3,9192 | 59,2774 | 0,1552 | 0,5361 |
sep.03 | 226,49 | 3,9677 | 57,0834 | -2,5095 | 1,2375 |
oct.03 | 218,37 | 3,9269 | 55,6087 | -3,5851 | -1,0283 |
nov.03 | 221,27 | 3,9364 | 56,2113 | 1,3280 | 0,2419 |
dec.03 | 215,48 | 3,7911 | 56,8384 | -2,6167 | -3,6912 |
jan.04 | 209,23 | 3,7357 | 56,0082 | -2,9005 | -1,4613 |
feb.04 | 207,51 | 3,8385 | 54,0602 | -0,8221 | 2,7518 |
mar.04 | 206,44 | 3,88 | 53,2062 | -0,5156 | 1,0812 |
apr.04 | 208,81 | 3,9731 | 52,5559 | 1,1480 | 2,3995 |
may.04 | 210,65 | 3,9279 | 53,6292 | 0,8812 | -1,1377 |
jun.04 | 208,29 | 3,7737 | 55,1952 | -1,1203 | -3,9258 |
jul.04 | 203,47 | 3,638 | 55,9291 | -2,3141 | -3,5959 |
aug.04 | 203,7 | 3,629 | 56,1312 | 0,1130 | -0,2474 |
sep.04 | 202,46 | 3,574 | 56,6480 | -0,6087 | -1,5156 |
oct.04 | 197,25 | 3,4534 | 57,1176 | -2,5733 | -3,3744 |

nov.04 | 188,66 | 3,2709 | 57,6783 | -4,3549 | -5,2846 |

dec.04 | 183,8 | 3,0963 | 59,3612 | -2,5761 | -5,3380 |
jan.05 | 188,11 | 3,1131 | 60,4253 | 2,3449 | 0,5426 |
feb.05 | 187,21 | 3,059 | 61,1997 | -0,4784 | -1,7378 |
mar.05 | 185,67 | 3,0493 | 60,8894 | -0,8226 | -0,3171 |
apr.05 | 191,71 | 3,2108 | 59,7079 | 3,2531 | 5,2963 |
may.05 | 198,58 | 3,2913 | 60,3348 | 3,5835 | 2,5072 |
jun.05 | 204,7 | 3,3382 | 61,3205 | 3,0819 | 1,4250 |
jul.05 | 204,58 | 3,4059 | 60,0664 | -0,0586 | 2,0280 |
aug.05 | 198,82 | 3,2884 | 60,4610 | -2,8155 | -3,4499 |
sep.05 | 201,22 | 3,2022 | 62,8380 | 1,2071 | -2,6213 |
oct.05 | 209,44 | 3,2636 | 64,1745 | 4,0851 | 1,9174 |
nov.05 | 213,17 | 3,3685 | 63,2834 | 1,7809 | 3,2142 |
dec.05 | 213,04 | 3,2474 | 65,6033 | -0,0610 | -3,5951 |
PACIFIC Exchange Rate Service
(C) 2012 Prof. Werner Antweiler, UBC

2. Describe the properties of changes in exchange rates and inflation rates differential
over this 10 years time.
Inflation is the rate at which the general level of prices for goods and services is rising, and,
subsequently, purchasing power is falling. Central banks attempt to stop severe inflation,
along with severe deflation, in an attempt to keep the excessive growth of prices to a
minimum.

As inflation rises, every dollar will buy a smaller percentage of a good. For example, if the
inflation rate is 2%, then a $1 pack of gum will cost $1.02 in a year.
Most countries' central banks will try to sustain an inflation rate of 2-3%.1
The cause of inflation, in general, is an over-supply of the currency meaning that the country
is importing more goods than exporting, thus creating a trade deficit.
The higher the inflation rate for USA, the less the purchasing power of the dollar in Hungary
or Poland. This means that if you want to exchange a dollar into HUF or PLN, you will get
less buying power.
Maintaining a low and stable inflation helps to protect the economy from inflation
consequences such as increased risk and loss of purchasing power. A high and volatile
inflation brings uncertainty and slows the economic growth.
Concearning the inflation rates of the two countries we can observe that Hungary is dealing
with high inflation in the first three years, while in the following years it manages to reach a
much lower level. On the other hand, Poland experiences a fluctuation in the early years and
in the following years there is a tendency to increase.
We can divide the HUF/USD exchange rates into two major periods in the first five years
the exchange rate had a downward trend and over the past five years it had some small
fluctuations. The highest value was registered in November 2001 (283,11), and the lowest
value was registered in July 2008 (147,07) PLN/USD.
PLN/USD exchanged in that period followed a downward trend, the highest value being
4,212 in September 2001, and the lowest, 2,064 in July 2008.

3. Regress the rate of exchange rate changes on the inflation rate differential and
interpret the regression results. Can your results be used to make a reliable forecast of
the future exchange rates of these currencies against the US dollar? If they cannot be
used, provide explanations for this.

http://www.investopedia.com/terms/i/inflation.asp

Regression Statistics |
Multiple R | 0,651821377 |
R Square | 0,424871108 |
Adjusted R Square | 0,419997134 |
Standard Error | 0,431252653 |
Observations | 120 |
Analysing the R-square value (not significantly different from 0) and the Significance F (>1),
we can conclude that the model is not representative. The data observed is not homogeneous,
thus reliable predictions cannot be made.
The coefficient of determinations (R Square) main purpose is either the prediction of future
outcomes or the testing of hypotheses, on the basis of other related information.2 The value of
R Square is 0,42 (close to 1), so this means that the regression model perfectly explains the
link between our two variables, population and employment.
F | Significance F |
87,17140003 | 7,45291E-16 |
The Significance F is 7,45 which means it is not a significant statistic regression because of
the fact that it is higher than 0,05.
| Coefficients | Standard Error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% |
Intercept | 0,193964969 | 0,039385238 | 4,924813951 | 2,77566E-06 | 0,115971476 |
0,271958462 | 0,115971476 |
-0,166342374 | 0,797087982 | 0,085372746 | 9,336562538 | 7,45291E-16 | 0,628026704 |
0,96614926 | 0,628026704 |

http://en.wikipedia.org/wiki/Coefficient_of_determination

The 95% confidence interval signifies that we can be 95% confident that the real value of the
coefficient we are estimating falls somewhere in that 95% confidence interval.
The P-value of 2,77 means that it is extremely unlikely for the event to occur and in this case
it shows that we cannot make a reliable forecast.