Professional Documents
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Exchange Rate Risk Management
Exchange Rate Risk Management
Forecasting Measuring
exchange exposure to
rates exchange rate
Managing fluctuations
exposure to
exchange rate
fluctuations
Forecasting Exchange Rates
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
1975 1980 1985 1990 1995 2000
Evaluation of Forecast Performance
$2.60
$2.40
Forward Rate
$2.20
$2.00
$1.80
$1.60
$1.40 Realized
$1.20 Spot Rate
$1.00
1975 1980 1985 1990 1995 2000
Forecast Bias
line
Region of
upward bias
(overestimating)
x
x z
Predicted Value
Graphic Evaluation of Forecast Performance
Using the Forward Rate as a Forecast for the British Pound
$2.50 Perfect
Forecast
Realized Spot Rate
Line
$2.00
$1.50
$1.00
$1.00 $1.50 $2.00 $2.50
Forecast (Forward Rate)
Graphic Evaluation
of Forecast Performance
• If the points appear to be scattered evenly
on both sides of the perfect forecast line,
then the forecasts are said to be unbiased.
• Note that a more thorough assessment
can be conducted by separating the entire
period into subperiods.
Comparison of
Forecasting Techniques
• The different forecasting techniques can
be evaluated
¤ graphically - by comparing the distances
from the perfect forecast line, or
¤ statistically - by computing the mean of the
absolute forecast errors, and then using a t-
test or a nonparametric test to determine
whether there is a significant difference in
the accuracy of the forecasting techniques.
Forecasting Under Market Efficiency
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