The specific objectives of this chapter is to: ■ explain how firms can benefit from forecasting exchange rates, ■ describe the common techniques used for forecasting, ■ explain how forecasting performance can be evaluated, and ■ explain how interval forecasts can be applied.

1. FORECASTING EXCHANGE RATES
P R O F E S S O R D R . M D . A M I N U L I S L A M
FA C U LT Y O F A P P L I E D A N D H U M A N
S C I E N C E S
U N I V E R S I T I M A L AY S I A P E R L I S
Vi s i t i n g P r o f e s s o r
D a ff o d i l I n t e r n a t i o n a l U n i v e r s i t y
a m i n @ u n i m a p . e d u . m y
W h a t s Ap p : + 6 0 1 6 4 0 4 9 0 8 7
M Y Y O U T U B E C H AN N E L :
P L AT F O R M F O R R E S E AR C H AN D
D E V E L O P M E N T
Knowledge Sincerity Excellence UniMAP

2. LEARNING OUTCOMES
After this session participants will be able to:
 Explain how firms can benefit from forecasting exchange
rates
 Describe the common techniques used for forecasting
 Explain how forecasting performance can be evaluated

3. Why Firms Forecast Exchange Rates
Exchange rate forecasts are necessary to evaluate the foreign
denominated cash flows involved in international transactions.
Thus, exchange rate forecasting is very important to evaluate the
benefits and risks attached to the international business environment.
Multinational corporations need exchange rate forecasts to make
decisions on hedging payables and receivables, short-term
financing and investment, capital budgeting, and long-term financing.
 Hedging decisions
 Short-term investment decisions
 Capital budgeting decisions
 Earnings assessment
 Long-term financing decisions

4. Forecasting Techniques
Exchange rate forecasting means to estimate the rate which will
be any of future date. It is just expectation of currency rate. In
future, our currency may be depreciated or may be appreciated.
There are 3 common methods of forecasting exchange rates:
1. Technical Forecasting
2. Fundamental Forecasting
3. Market-Based Forecasting

5. Technical Forecasting
Technical analysis is a currency forecasting technique that uses
historical prices or trends. This focuses solely on past prices and
volume movements not on economic and political factors.
1. Involves the use of historical exchange rate data to
predict future values
2. Limitations of technical forecasting:
a. Focuses on the near future
b. Rarely provides point estimates or range of possible future
values
c. Technical forecasting model that worked well in one period may
not work well in another

6. Fundamental Forecasting
This is a forecasting technique that utilizes elementary data
related to a country, such as GDP, inflation rates,
productivity, balance of trade, and unemployment rate.
1. Based on fundamental relationships between economic
variables and exchange rates
2. Use of sensitivity analysis to account for uncertainty by
considering more than one possible outcome.
3. Use of PPP for fundamental analysis by forecasting inflation
rate differentials

7. Fundamental Forecasting
Limitations of fundamental forecasting include:
a. Unknown timing of the impact of some factors
b. Forecasts of some factors may be difficult to obtain
c. Some factors are not easily quantified
d. Regression coefficients may not remain constant

8. Market-Based Forecasting
Market-based forecasts should reflect an expectation of the
market on future rates. If the market's expectation differed from
existing rates, then the market participants should react by taking
positions in various currencies until the current rates do reflect an
expectation of the future.
1. Use of the spot rate to forecast the future spot rate.
2. Use of the forward rate to forecast the future spot rate
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9. Mixed Forecasting
Mixed forecasting is a composite of two or more
methods. The same or different weight can be assigned
to each method in mixed forecasting. One issue in
exchange rate forecast is to forecast exchange rate
using high frequency data in shorter period such as in a
day or a week.
1. Use a combination of forecasting techniques
2. Mixed forecast is then a weighted average of the various
forecasts developed

10. Forecasting under Market Efficiency
 Weak-form efficiency: historical and current exchange rate
information is already reflected in today’s exchange rate
and is not useful for forecasting.
 Semistrong-form efficiency: all relevant public information
is already reflected in today’s exchange rate.
 Strong-form efficiency: all relevant public and private
information is already reflected in today’s exchange rate.

11. Methods of Forecasting Exchange Rate Volatility
Currency exchange rate forecasts help brokers and businesses
make better decisions. There are 3 Common Ways to Forecast
Currency Exchange Rates
 Purchasing power parity looks at the prices of goods in
different countries and is one of the more widely used methods
for forecasting exchange rates due to its indoctrination in
textbooks.
 The relative economic strength approach compares levels of
economic growth across countries to forecast exchange rates.
 Lastly, econometric models can consider a wide range of
variables when attempting to understand trends in the currency
markets.
1. Use of recent volatility level
2. Use of historical pattern of volatilities

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