Lecture Week 5- Foreign Exchange Markets II

FIN3IFM: International Financial Management Lecture 05 The Foreign Exchange Market (II) Lecture Objectives Explain why firms forecast exchange rates Describe the common forecasting techniques Explain how to evaluate forecasting performance Explain how to account for the uncertainty surrounding forecasts  Explain the forward markets, forward contract and their use  Explain the future markets, future contract and their use  Describe the characteristics and use of currency call and put option contracts     Part 1: Forecasting Exchange Rates Part 1.A Why Forecasting Exchange Rate? Why Firms Forecast Exchange Rates? (1 of 3)  Hedging decisions  Firms’ decision to hedges receivals or payables is determined by its forecasts of foreign currency values  Short-term investment decisions  Corporations with short-term substantial amount of excess cash make investment decision  Firms build large deposits in several currencies – with high interest rate, stronger currencies  Capital budgeting decisions  MNC’s parent assesses whether to invest funds in a foreign project,  Decision involves cash flow measurement in local currency Why Firms Forecast Exchange Rates? (2 of 3)  Earnings assessment  The parent’s decision about whether a foreign subsidiary should reinvest earnings in a foreign country or remit earnings back to the parent may be influenced by exchange rate forecasts  Long-term financing decisions  MNCs that issue bonds to secure long-term funds may consider denominating the bonds in foreign currencies  MNCs prefer that the borrowing currency depreciate over time  Forecasts of exchange rates help to estimate the cost of issuing bonds Summary - Motives for Forecasting Exchange Rates Part 1.B Forecasting Techniques Forecasting Techniques  Technical Forecasting  Fundamental Forecasting  Market-Based Forecasting  Mixed Forecasting (1 of 10) Forecasting Techniques (2 of 10)  Technical Forecasting Involves the use of historical exchange rate data to predict future exchange rate  Limitations of technical forecasting:  Useful for very short-term periods  It may work well in one particular period but may not work well in another period  If the foreign exchange market is weak-form efficient then technical analysis would not be able to improve upon today’s exchange rates when forecasting those rates in the near future ... call and put option contracts     Part 1: Forecasting Exchange Rates Part 1.A Why Forecasting Exchange Rate? Why Firms Forecast Exchange Rates? (1 of 3)  Hedging decisions  Firms’ decision... in a foreign project,  Decision involves cash flow measurement in local currency Why Firms Forecast Exchange Rates? (2 of 3)  Earnings assessment  The parent’s decision about whether a foreign. .. foreign currencies  MNCs prefer that the borrowing currency depreciate over time  Forecasts of exchange rates help to estimate the cost of issuing bonds Summary - Motives for Forecasting Exchange