This document discusses why MNCs forecast exchange rates and different techniques for doing so. MNCs need to forecast exchange rates for hedging decisions, short-term financing, investments, capital budgeting, earnings assessments, and long-term financing. Exchange rate forecasts help MNCs determine things like whether to hedge currency risk, which currency to borrow in, and whether to remit foreign subsidiary earnings. There are four main categories of forecasting techniques: technical analysis of historical exchange rate data, fundamental analysis of economic factors affecting exchange rates, market-based analysis using current spot or forward rates, and subjective assessments.

1. Chapter - 9
Forecasting Exchange Rates

2. • MNCs need exchange rate forecasts for their:
– Hedging Decisions
– Short-term Financing Decisions
– Short-term Investment Decisions
– Capital Budgeting Decisions
– Long-term Financing Decisions
– Earnings Assessment
Why Firms Forecast Exchange Rates

3. Why Firms Forecast Exchange Rates
• Hedging Decision
– MNCs 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:
1) a low interest rate and
2) weaken in value over the financing period.

4. Why Firms Forecast Exchange Rates
• Short-term Investment Decision
– Corporations sometimes have a substantial amount of excess
cash available for a short time period.
– The ideal currency they deposits ideally exhibit:
1) a high interest rate and
2) strengthen in value over the investment period.
• Capital Budgeting Decision
– When an 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 the parent’s local currency.

5. Why Firms Forecast Exchange Rates
• Earnings Assessment
– The parent’s decision about whether a foreign subsidiary:
 Reinvest earnings in a foreign country or
 Remit earnings back to the parent.
– Decision may be influenced by exchange rate forecasts.
 If a strong foreign currency is expected to weaken
substantially, the parent may prefer to expedite the
remittance earnings before the foreign currency weakens.
– When earnings of an MNC are reported, subsidiary earnings
are consolidated and translated into the currency
representing the parent firm’s home country.

6. Why Firms Forecast Exchange Rates
• 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 rates are required.

7. Forecasting Techniques
• Numerous methods available for forecasting
exchange rates can be categorized into four general
groups:
1. Technical Forecasting
2. Fundamental Forecasting
3. Market Based Forecasting

8. • 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.
Forecasting Techniques

9. • Fundamental Forecasting
– Fundamental forecasting is based on fundamental
relationships between economic variables &
exchange rates.
– A forecast may arise simply from a subjective
assessment of the factors that affect exchange rates.
– Changes in a currency’s spot rate is influenced by the
following factors:
Forecasting Techniques

10. • Market-Based Forecasting
– The process of developing forecasts from market
indicators, is usually based on either;
1. Spot rate or
2. Forward rate.
– Speculation should push the rates to the level that
reflect the market expectation of the future exchange
rate.
– Corporations can use the spot rate to forecast since it
represents the market’s expectation of the spot rate in
the near future.
Forecasting Techniques