Forecasting techniques used in the foreign exchange market.

1. EXCHANGE RATE
FORECASTING

2. WHY FIRMS FORECAST EXCHANGE
RATES
 Hedging decision
 MNC’s constantly face the decision of whether to
hedge future payables and receivables in foreign
currencies.
 Whether a firm hedges may be determined by its
forecasts of foreign currency values.
 short-term financing decision
 When large corporations borrow, they have access to
several different currencies.
 The currency they borrow will ideally exhibit a low
interest rate and weaken in value over the financing

3. WHY FIRMS FORECAST EXCHANGE
RATES
 Capital budgeting decision
 when a MNC’s parent assesses whether to invest funds in a
foreign project, the firm takes into account that
 The project may periodically require the exchange of currencies.
 Analysis can be completed only when all estimated cash flows
are measured in parent’s local currency.
 Long term financing decision
 Corporations that issue bonds to secure long term funds may
prefer that the currency borrowed, depreciate over time against the
currency they are receiving from sales.
 To estimate the cost of issuing bonds denominated in a foreign
currency, forecasts of exchange rate are required

4. TWO APPROACHES TO FORECASTING
 Fundamental analysis- It studies the relationship
between macro economic variables such as
inflation rates, national income growth and
changes in money and exchange rates to forecast
later. Long term projections.
 Technical analysis- The technical analysis may
produce useful results if the past trend is repeated.
The companies normally use technical analysis for
short term forecast.

5. TECHNICAL ANALYSIS

6. Technical forecasting
 Technical forecasting involves the use of
historical exchange rate data to predict future
values.
 There may be a trend of successive exchange
rate adjustments in the same direction.
 It includes statistical analysis and time series
models.
 Speculators may find the models useful for
predicting day-to-day movements.
 However,since they typically Focus on the near
future and rarely provide point/range estimates,
they are of limited use to Mncs.

7. FUNDAMENTAL ANALYSIS

8. INFLATION
 Inflation is the increase in the prices of goods
and services over time.
 As prices rise, a single unit of currency loses
value as it buys fewer goods and services.
 This loss of purchasing power impacts the
general cost of living for the common public which
ultimately leads to a deceleration in economic
growth.

9.  Negative effects include an increase in
opportunity cost of holding money, uncertainty
over future inflation which may discourage
investment and savings, and if inflation were
rapid enough, shortages of goods as consumers
begin hording out of concern that prices will
increase in future.
 Positive effects include ensuring that central
banks can adjust real interest rates , and
encouraging investment

10.  Economists perception- high rates of inflation
and hyperinflation are caused by excessive
growth of money supply.
 Low or moderate inflation may be attributed to
fluctuations in real demand for goods and
services, or changes in available supplies such
as during scarcities, as well as to changes in
velocity of money supply measures.
 Economists favor a low and steady rate of
inflation.
 Low inflation reduces severity of economic
recessions by enabling labor market to adjust
more quickly in a downturn, and reduces risk that
a liquidity trap prevents monitory policy from
stabilizing economy.

11. PURCHASING POWER PARITY
 Exchange rate adjusts so that an identical good in
two different countries has the same price when
expressed in the same currency.
 Purchasing power parity forecasting approach is
based on theoretical Law of One Price
 Identical goods in different countries should have
identical prices.

12.  For example: A Shoe in the US costs $70, and that in
Indian Rupees is 4900 , but a in India it costs
around 2000 Rs. This creates an
arbitrage opportunity where people in India can stock
up on shoe and bring it to the US and sell it and
make a nice profit. Purchasing Power Parity says
that since they are the same goods, the purchasing
power in the countries should be the same. This
doesn’t mean the exchange rate should be equal to
one; it means the ratio of price to exchange rate
should be one. so if the pair of shoes costs Rs. 2000
in India , then it should cost $28 in US when the
exchange rate is Rs.70 between the dollar and the
rupee.

13. GROSS NATIONAL PRODUCT (GNP)
INTRODUCTION:
 Gross national product (GNP) is the value of all goods and
services made by a country's residents and businesses,
regardless of production location. GNP counts the
investments made by U.S. residents and businesses—both
inside and outside the country—and computes the value of
all products manufactured by domestic companies,
regardless of where they are made.
 GNP doesn't count any income earned in the United States
by foreign residents or businesses, and excludes products
manufactured in the United States by overseas firms.

14. GNP Formula
The formula to calculate the components of GNP is Y =
C + I + G + X + Z.
That stands for GNP = Consumption + Investment +
Government + X (net exports) + Z (net income earned by
domestic residents from overseas investments minus net
income earned by foreign residents from domestic
investments).

15. GNP GROWTH
 An economic statistic that includes GDP, plus any
income earned by residents from overseas investments,
minus income earned within the domestic economy by
overseas residents.
 GNP is a measure of a country's economic
performance, or what its citizens produced (i.e. goods
and services) and whether they produced these items
within its borders OR outside

16. ASSET MARKET
INTRODUCTION:
 Demand for goods produced in a country explains partly demand
for currency of particular country.
 It has to be recognized that demand for currency also arises from
desire to hold stock of assets, denominated in that currency.
 Assets are traded in markets around the world. Typically, there
are a large number of (potential) buyers and sellers for any given
asset: thousands of people might be willing to buy Microsoft
Corporation stock or sell government bonds if they felt the price
was right. Also, assets are homogeneous: one US government
10-year bond is the same as another. This means that asset
markets are a good example of competitive markets, which
means that we can look at asset markets using supply and
demand.

17. STRENGTH AND WEAKNESS OF ASSET MARKET
 Financial system
 Financial assets
 Health of the financial system
 Financial market

18. MONETARY POLICY
 Monetary policy is process by which monetary authority of a
country controls supply of money often targeting a rate of
interest for promoting economic growth and stability.
 Official goals usually include relatively stable prices and low
unemployment.
 Monetary economics provides insight into how to craft optimal
monetary policy.
 Monetary policy differs from fiscal policy, which refers to
taxation, government spending, and associated borrowing.
 Monitory Policy is either expansionary or contractionary.

19. RELATIVE ECONOMIC STRENGTH
APPROACH
 Relative economic strength approach looks at
strength of economic growth in different countries
in to forecast direction of exchange rates.
 A strong economic environment and potentially
high growth is more likely to attract investments
from foreign investors.
 High interest rates will attract investors looking for
highest yield on their investments, causing
demand for the currency to increase, which again
would result in an appreciation of currency.

20.  This approach doesn't just look at relative economic
strength between countries.
 It takes a more general view and looks at all investment
flows.
 Unlike PPP approach, relative economic strength
approach doesn't forecast what the exchange rate should
be.
 This approach gives investor a general sense of whether
a currency is going to appreciate or depreciate and an
overall feel of movement.
 It is used in combination with other forecasting methods

21. Types of Forex charts
Line charts:
A simple line chart draws a line from one closing price
to next closing price. When strung together with a
line, we can see general price movement of a
currency pair over a period of time.

22. Bar charts
A bar chart also shows closing prices, while
simultaneously showing opening prices, as well
as highs and lows.

23. Candlestick charts
Candlestick charts show same information as a bar
chart, but in a prettier, graphic format.
Traditionally, if the block in the middle is filled or
colored in, then currency closed lower than it opened.

24. Conclusion
Economists and investors tend to forecast the
future exchange rates so that they can depend on
the predictions to derive monetary value. The
forecasting models are full of complexities and
none of them can claim to be 100% accurate in
deriving the exact future exchange rate.
Forecasting exchange rates is a very difficult task,
so companies and investors simply hedge their
currency risk.