Exchange Rate Forecasting

Why do you need to predict future exchange rate?

 Decision making
 Worthwhile for an entity to invest on exchange rate forecasting services to aid decision
making.

The Efficiency Market vs The Inefficiency Market

Forward Exchange rates vs Investing in Forecasting Services

 forward exchange rate represents market participants collective predictions of likely spot
exchange rates at specified future dates
 Inefficient market – prices do not reflect all available information so forward exchange rates
here are not sufficient data.
 Here Investing in forecasting services might be the better option since it predicts better that
that of forward exchange rates do
 However, in recent times it has not been helpful
 Some example in history is the 1997 currency crisis in Asia
 Dollar rise in 2008 which caused the us to undergo financial crisis

Approaches to forecasting – only if the inefficient market proves that there is insufficient data what
would be its basis?

• Fundamental Analysis and Technical Analysis

• Fundamental Analysis

- Draws on economic theory to construct econometric models for predicting

exchange rate movement. Which focuses on the money supply growth rate,
inflation rates and interest rates.
- On hold of dollars on the effect of holding it could have an impact of the county. It
would cause pressure that could let depreciation of the dollars’ worth

 Technical Analysis
- Uses price and volume data to determine past trends, which are expected to
continue in the future.
- This analysis pertains to the idea that future trends can be analyzed through past
trends
- Also seen as fortune telling
- Despite the skepticism this is favored over the years
   fundamental analysis focuses on a security's intrinsic value based on things like the
company's financial statements, the overall economy and market conditions and other
factors like liabilities and assets. While technical analysis focuses on a security's price
movements and volume, fundamental analysis looks at how viable the company is on
a fundamental level. 

Currency Convertibility

 A significant number of countries do not freely convert other countries’ currency to their
own
 A countries currency is freely convertible when the country’s government allows both
resident and nonresidents to purchase unlimited amount of a foreign currency
 A currency is externally convertible and nonconvertible
externally convertible – nonresidents convert it to foreign currency without any
limitation
- Free convertibility is not universal
- Restriction of residents to convert domestic currency into a foreign currency
o Japan and US
nonconvertible – neither resident nor nonresident can convert it into a foreign currency
-Russia

Government – limits convertibility to preserve their foreign exchange reserves. A

country needs a significant amount of reserves to service its debts and to import goods
and services. One aspect that drives this occasion is Capital flight wherein residents and
nonresidents hastily convert domestic currency into foreign ones.
Capital flight occurs when domestic currency depreciates in value rapidly and
people see it as an opportunity to invest in money conversion. They believe that their
money will have a more reliable outcome if they invest it at abroad.
Countertrade – agreements by which goods or services are traded for other
goods and services this is mostly applicable if a countries currency is nonconvertible.