Chapter

9
Forecasting Exchange Rates
 Why Firms Forecast
Exchange Rates
• MNCs need exchange rate forecasts for
their:
¤ hedging decisions,
¤ short-term financing decisions,
¤ short-term investment decisions,
¤ capital budgeting decisions,
¤ long-term financing decisions, and
¤ earnings assessment.

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 Forecasting Techniques

• The numerous methods available for

forecasting exchange rates can be
categorized into four general groups:
 technical,
 fundamental,
 market-based,and
 mixed.

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 Technical Forecasting
• Technical forecasting involves the use of
historical data to predict future values. It includes
¤ statistical analysis and
¤ time series models.

• Models charts used for day to day movements.

• These are Short term hence of limited value

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 Fundamental Forecasting

• is based on the fundamental relationships

between
¤ economic variables and exchange rates.

• A forecast may arise simply from a

subjective assessment of the factors that
affect exchange rates.
• A forecast may be based on quantitative
measurements (with the aid of regression
models and sensitivity analysis) too.
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Market-Based Forecasting

• Market-based forecasting 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 that reflect the
market expectation of the future exchange
rate.

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 Mixed Forecasting

• Mixed forecasting refers to the use of a

combination of forecasting techniques.
• The actual forecast is a weighted average
of the various forecasts developed.

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Impact of Forecasted Exchange Rates
on an MNC’s Value
Technical Forecasting
Fundamental Forecasting
Market-based Forecasting
Mixed Forecasting

m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t

 
E (CFj,t ) = expected cash flows in currency j to be received
by the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
k = weighted average cost of capital of the parent
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 Exercises

• A Ltd which has imported machinery from

US has to decide whether to pay now or to
utilize credit period offered by US supplier
• B Ltd intends to go for a loan in yen to
finance its US operations
• C Ltd has surplus cash and needs to
deposit it in a bank in US or UK

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