Exam 9: Forecasting Exchange Rates

When measuring forecast performance of different currencies, it is often useful to adjust for their relative sizes. Thus, percentages, rather than nominal amounts, are often used to compute forecast errors.

The following regression model was estimated to forecast the percentage change in the Australian Dollar (AUD): AUD_t = a₀ + a₁INT_t + a₂INF_{t - 1} + $\mu$ _t, Where AUD is the quarterly change in the Australian Dollar, INT is the real interest rate differential in period t between the U.S. and Australia, and INF is the inflation rate differential between the U.S. and Australia in the previous period. Regression results indicate coefficients of a₀ = .001; a₁ = -.8; and a₂ = .5. Assume that INF_{t - 1} = 4%. However, the interest rate differential is not known at the beginning of period t and must be estimated. You have developed the following probability distribution: There is a 20% probability that the Australian dollar will change by ____, and an 80% probability it will change by ____.

Assume that U.S. annual inflation equals 8%, while Japanese annual inflation equals 5%. If purchasing power parity is used to forecast the future spot rate, the forecast would reflect an expectation of:

Which of the following is not a method of forecasting exchange rate volatility?

If the forward rate is used as an indicator of the future spot rate, the spot rate is expected to appreciate or depreciate by the same amount as the forward premium or discount, respectively.

Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro: The most recent quarterly percentage change in the inflation differential between the U.S. and Europe was 2 percent, while the most recent quarterly percentage change in the income growth differential between the U.S. and Europe was -1 percent. Based on this information, the forecast for the euro is a(n) ____ of ____%.

Market-based forecasting is based on fundamental relationships between economic variables and exchange rates.

Market-based forecasting involves the use of historical exchange rate data to predict future values.

Assume that U.S. interest rate for the next three years is 5%, 6%, and 7% respectively. Also assume that Canadian interest rates for the next three years are 3%, 6%, 9%. The current Canadian spot rate is $.840. What is the approximate three-year forecast of Canadian dollar spot rate if the three-year forward rate is used as a forecast?

The most sophisticated forecasting techniques provide consistently accurate forecasts.

If the pattern of currency values over time appears random, then technical forecasting is appropriate.

If today's exchange rate reflects any historical trends in Canadian dollar exchange rate movements, but not all relevant public information, then the Canadian dollar market is:

In general, any key managerial decision that is based on forecasted exchange rates should rely completely on one forecast rather than alternative exchange rate scenarios.

Pro Corp, a U.S.-based MNC, uses purchasing power parity to forecast the value of the Thai baht (THB), which has a current exchange rate of $0.022. Inflation in the U.S. is expected to be 3% during the next year, while inflation in Thailand is expected to be 10%. Under this scenario, Pro Corp would forecast the value of the baht at the end of the year to be:

If a particular currency is consistently declining substantially over time, then a market-based forecast will usually have:

The U.S. inflation rate is expected to be 4 percent over the next year, while the European inflation rate is expected to be 3 percent. The current spot rate of the euro is $1.03. Using purchasing power parity, the expected spot rate at the end of one year is $____.

Which of the following forecasting techniques would best represent the use of today's forward exchange rate to forecast the future exchange rate?

Which of the following forecasting techniques would best represent the sole use of the pattern of historical currency values of the euro to predict the euro's future currency value?

Severus Co. has to pay 5 million Canadian dollars for supplies it recently received from Canada. Today, the Canadian dollar has appreciated by 2 percent against the U.S. dollar. Severus has determined that whenever the Canadian dollar appreciates against the U.S. dollar by more than 1 percent, it experiences a reversal of 40 percent on the following day. Based on this information, the Canadian dollar is expected to ____ tomorrow, and Severus would prefer to make payment ____.

Sensitivity analysis allows for all of the following except: