Deck 9: Forecasting Exchange Rates

Question 1

In market-based forecasting, a forward rate quoted for a specific date in the future can be used as the forecasted spot rate on that future date.

Answer 1

True

Question 2

If the forward rate is used as an indicator of the future spot rate, the spot rate is expected to appreciate or depreciate by the same amount as the forward premium or discount, respectively.

Answer 2

True

Question 3

Usually, fundamental forecasting is used for short-term forecasts, while technical forecasting is used for longer-term forecasts.

Answer 3

False

Question 4

The closer graphical points are to the perfect forecast line, the better the forecast.

Question 5

If graphical points lie above the perfect forecast line, then the forecast overestimated the future value.

Question 6

MNCs can forecast exchange rate volatility to determine the potential range surrounding their exchange rate forecast.

Question 7

If foreign exchange markets are weak-form efficient, then all relevant public and private information is already reflected in today's exchange rates.

Question 8

A motivation for forecasting exchange rate volatility is to obtain a range surrounding the forecast.

Question 9

Foreign exchange markets appear to be strong-form efficient.

Question 10

Exchange rates one year in advance are typically forecasted with almost perfect accuracy for the major currencies, but not for currencies of smaller countries.

Question 11

Inflation and interest rate differentials between the United States and foreign countries are examples of variables that could be used in fundamental forecasting.

Question 12

When measuring a forecasting technique's performance among different currencies, it is often useful to examine the relative size of the discrepancies between the forecasted and realized values. Thus, percentages, rather than nominal amounts, are often used to measure forecast errors.

Question 13

Market-based forecasting involves the use of historical exchange rate data to predict future values.

Question 14

In general, any key managerial decision that is based on forecasted exchange rates should rely completely on one forecast rather than alternative exchange rate scenarios.

Question 15

A regression analysis of the Australian dollar's value on the inflation differential between the United States and Australia produced a coefficient of .8. Thus, for every 1 percent increase in the inflation differential, the Australian dollar is expected to depreciate by .8 percent.

Question 16

If the pattern of currency values over time appears random, then technical forecasting is appropriate.

Question 17

The ideal currency for short-term deposits by an MNC will exhibit a high interest rate and appreciate over the investment period.

Question 18

The most sophisticated forecasting techniques provide consistently accurate forecasts.

Question 19

Two methods for assessing exchange rate volatility are to use the volatility of historical exchange rate movements and to derive the exchange rate's implied standard deviation from the currency option pricing model.

Question 20

Corporations tend to make only limited use of technical forecasting because it typically focuses on the near future, which is not very helpful for developing corporate policies.

Question 21

If a foreign country's interest rate is similar to the U.S. rate, the forward rate premium or discount will be close to zero, meaning that the forward rate and the spot rate will provide similar forecasts.

Question 22

Different departments in an MNC should establish their own exchange rate forecasts because each department can best determine the type of forecasts that it needs.

Question 23

The potential forecast error is larger for currencies that are more volatile.

Question 24

Which of the following is not a method of forecasting exchange rate volatility?

A) using the absolute forecast error as a percentage of the realized value
B) using the volatility of historical exchange rate movements as a forecast for the future
C) using a time series of volatility patterns in previous periods
D) deriving the exchange rate's implied standard deviation from the currency option pricing model

Question 25

If the forward rate is expected to be an unbiased estimate of the future spot rate, and interest rate parity holds, then:​

A) ​covered interest arbitrage is feasible.
B) ​the international Fisher effect (IFE) is supported.
C) ​the international Fisher effect (IFE) is refuted.
D) ​the average absolute error from forecasting would equal zero.

Question 26

When a U.S.-based MNC wants to determine whether to establish a subsidiary in a foreign country, it will always accept that project if the foreign currency is expected to appreciate.

Question 27

If points are scattered evenly on both sides of the perfect forecast line, then the forecast appears to be very accurate.

Question 28

According to the text, research generally supports ____ in foreign exchange markets.

A) weak-form efficiency
B) semistrong-form efficiency
C) strong-form efficiency
D) weak-form efficiency AND semistrong-form efficiency
E) semistrong-form efficiency AND strong-form efficiency

Question 29

Research indicates that currency forecasting services almost always outperform forecasts based on the forward rate.

Question 30

A forecast of a currency one year in advance is typically more accurate than a forecast one week in advance since the currency reverts to equilibrium over a longer term period.

Question 31

Forecast errors tend to be large for short forecast horizons.

Question 32

Fundamental models examine moving averages over time and thus allow the development of a forecasting rule.

Question 33

Market-based forecasting is based on fundamental relationships between economic variables and exchange rates.

Question 34

Severus Co. has to pay 5 million Canadian dollars for supplies it recently received from Canada. Today, the Canadian dollar has appreciated by 2 percent against the U.S. dollar. Severus has determined that whenever the Canadian dollar appreciates against the U.S. dollar by more than 1 percent, it experiences a reversal of 40 percent of that change on the following day. Based on this information, the Canadian dollar is expected to ____ tomorrow, and Severus would prefer to make payment ____.​

A) ​depreciate by .8 percent; today
B) ​depreciate by .8 percent; tomorrow
C) ​appreciate by .8 percent; today
D) ​appreciate by .8 percent; tomorrow

Question 35

Leila Corp. used the following regression model to determine if the forecasts over the last ten years were biased: ​
S_t = a₀ + a₁F_{t - 1} + $\mu$ _t,
​
Where S_t is the spot rate of the yen in year t and F_{t - 1} is the forward rate of the yen in year t - 1. Regression results reveal coefficients of a₀ = 0 and a₁ = .30. Thus, Leila Corp. has reason to believe that its past forecasts have ____ the realized spot rate.

A) overestimated
B) underestimated
C) correctly estimated
D) None of these are correct.

Question 36

​Which of the following forecasting techniques would be most likely to use relationships between economic factors and exchange rate movements to forecast the future exchange rate?

A) ​fundamental forecasting
B) ​market-based forecasting
C) ​technical forecasting
D) ​mixed forecasting

Question 37

Gamma Corp. has incurred large losses over the last ten years due to exchange rate fluctuations of the Egyptian pound (EGP), even though the company has used a market-based forecast based on the forward rate. Consequently, management believes its forecasts are biased. The following regression model was estimated to determine if the forecasts over the last ten years were biased: ​
S_t = a₀ + a₁F_{t - 1} + F $\mu$ _t,
​
Where S_t is the spot rate of the pound in year t and F_{t -1} is the forward rate of the pound in year t_-
Regression results reveal coefficients of a₀ = 0 and a₁ = 1.3. Thus, Gamma has reason to believe that its past forecasts have ____ the realized spot rate.

A) overestimated
B) underestimated
C) correctly estimated
D) None of these are correct.

Question 38

Since the forward rate does not capture the nominal interest rate between two countries, it should provide a less accurate forecast for currencies in high-inflation countries than the spot rate.

Question 39

A forecasting technique based on fundamental relationships between economic variables and exchange rates, such as inflation, is referred to as technical forecasting.

Question 40

Using the inflation differential between two countries to forecast their exchange rates is not always accurate because of such factors as the uncertain timing of the impact of inflation and barriers to trade.

Question 41

If speculators expect the spot rate of the yen in 60 days to be ____ than the 60-day forward rate on the yen, they will ____ the yen forward and put ____ pressure on the yen's forward rate.​

A) ​higher; buy; upward
B) ​higher; sell; downward
C) ​higher; sell; upward
D) ​lower; buy; upward

Question 42

Assume that U.S. annual inflation equals 8 percent, while Japanese annual inflation equals 5 percent. If purchasing power parity is used to forecast the future spot rate, the forecast would reflect an expectation of:

A) appreciation of the yen's value over the next year.
B) depreciation of the yen's value over the next year.
C) no change in the yen's value over the next year.
D) Information about interest rates is needed to answer this question.

Question 43

​Which of the following forecasting techniques would be most likely to use the historical exchange rate data for the euro to predict the euro's future exchange rate?

A) ​fundamental forecasting
B) ​market-based forecasting
C) ​technical forecasting
D) ​mixed forecasting

Question 44

If today's exchange rate reflects any historical trends in Canadian dollar exchange rate movements, but not all relevant public information, then the Canadian dollar market is:

A) weak-form efficient.
B) semistrong-form efficient.
C) strong-form efficient.
D) All of these are correct.

Question 45

​Which of the following forecasting techniques would be most likely to use today's spot exchange rate of the euro to forecast the euro's future exchange rate?

A) ​fundamental forecasting
B) ​market-based forecasting
C) ​technical forecasting
D) ​mixed forecasting

Question 46

Assume that the forward rate is used to forecast the spot rate. The forward rate of the Canadian dollar contains a 6 percent discount. Today's spot rate of the Canadian dollar is $.80. The spot rate forecasted for one year ahead is:

A) $.860.
B) $.848.
C) $.740.
D) $.752.
E) None of these are correct.

Question 47

Purchasing power parity is used in:

A) technical forecasting.
B) fundamental forecasting.
C) market-based accounting.
D) All of these are correct.

Question 48

Which of the following is not a limitation of technical forecasting?

A) It's not suitable for long-term forecasts of exchange rates.
B) It doesn't provide point estimates or a range of possible future values.
C) It cannot be applied to currencies that exhibit random movements.
D) It cannot be applied to currencies that exhibit a continuous trend for short-term forecasts.

Question 49

Assume that U.S. interest rates for the next three years are 5 percent, 6 percent, and 7 percent, respectively. Also assume that Canadian interest rates for the next three years are 3 percent, 6 percent, and 9 percent. The current Canadian spot rate is $.840. What is the approximate three-year forecast of the Canadian dollar's spot rate if the three-year forward rate is used as a forecast?

A) $.840
B) $.890
C) $.856
D) $.854

Question 50

Which of the following is true?

A) Forecast errors cannot be negative.
B) Forecast errors are negative when the forecasted rate exceeds the realized rate.
C) Absolute forecast errors are negative when the forecasted rate exceeds the realized rate.
D) None of these are correct.

Question 51

The absolute forecast error of a currency is ____, on average, in periods when the currency is more ____.

A) lower; volatile
B) higher; stable
C) lower; stable
D) None of these are correct.

Question 52

Which of the following is true regarding forecast errors?

A) Forecasts for the Chinese yuan are likely to have large forecast errors because the yuan is a volatile currency.
B) Potential forecast errors may vary depending on the time horizon, the currency's volatility, and whether the country issuing the currency is experiencing political problems.
C) Forecasts for currencies in high-inflation countries will be more accurate if they use the spot rate rather than the forward rate because the spot rate captures the difference in interest rates (and thus inflation rates) between two countries.
D) Potential forecast errors may vary depending on the time horizon, the currency's volatility, and whether the country issuing the currency is experiencing political problems AND forecasts for currencies in high-inflation countries will be more accurate if they use the spot rate rather than the forward rate because the spot rate captures the difference in interest rates (and thus inflation rates) between two countries.

Question 53

Assume that interest rate parity holds. The U.S. five-year interest rate is 5 percent annualized, and the Mexican five-year interest rate is 8 percent annualized. Today's spot rate of the Mexican peso is $.20. What is the approximate five-year forecast of the peso's spot rate if the five-year forward rate is used as a forecast?

A) $.131
B) $.226
C) $.262
D) $.140
E) $.174

Question 54

If the foreign exchange market is ____ efficient, then historical and current exchange rate information is not useful for forecasting exchange rate movements.

A) weak-form
B) semistrong-form
C) semiweak-form
D) weak-form AND semistrong-form

Question 55

​Assume a forecasting model uses inflation differentials and interest rate differentials to forecast the exchange rate. Assume the regression coefficient of the interest rate differential variable is -.5, and the coefficient of the inflation differential variable is .4. Which of the following is true?

A) ​The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly (positively) related to the interest rate variable.
B) ​The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly related to the exchange rate.
C) ​The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the exchange rate.
D) ​The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the interest rate variable.

Question 56

If speculators expect the spot rate of the Canadian dollar in 30 days to be ____ than the 30-day forward rate on Canadian dollars, they will ____ Canadian dollars forward and put ____ pressure on the Canadian dollar forward rate.​

A) ​lower; sell; upward
B) ​lower; sell; downward
C) ​higher; sell; upward
D) ​higher; sell; downward

Question 57

Which of the following is not a forecasting technique mentioned in your text?

A) accounting-based forecasting
B) technical forecasting
C) fundamental forecasting
D) market-based forecasting

Question 58

Which of the following is not a limitation of fundamental forecasting?

A) uncertain timing of the impact of some factors
B) forecasts needed for factors that have a lagged impact
C) omission of other relevant factors from the model
D) possible change in sensitivity of the forecasted variable to each factor over time
E) None of these are correct.

Question 59

If it was determined that the movement of exchange rates was not related to previous exchange rate values, this implies that a ____ is not valuable for speculating on expected exchange rate movements.

A) technical forecast technique
B) fundamental forecast technique
C) All of these are correct.
D) None of these are correct.

Question 60

When the value of an influential factor from the prior period affects the forecast in the future period, this is an example of a(n):

A) lagged input
B) instantaneous input
C) simultaneous input
D) instantaneous input AND simultaneous input

Question 61

Assume that the U.S. interest rate is 11 percent, while Australia's one-year interest rate is 12 percent. Assume interest rate parity holds. If the one-year forward rate of the Australian dollar was used to forecast the future spot rate, the forecast would reflect an expectation of:

A) depreciation in the Australian dollar's value over the next year.
B) appreciation in the Australian dollar's value over the next year.
C) no change in the Australian dollar's value over the next year.
D) Information on future interest rates is needed to answer this question.

Question 62

If a foreign country's interest rate is similar to the U.S. rate, the forward rate premium or discount will be ____, meaning that the forward rate and the spot rate will provide ____ forecasts.​

A) ​substantial; similar
B) ​substantial; very different
C) ​close to zero; similar
D) ​close to zero; very different

Question 63

​A fundamental forecast that uses multiple values of the influential factors is an example of:

A) ​sensitivity analysis.
B) ​discriminant analysis.
C) ​technical analysis.
D) ​factor analysis.

Question 64

Assume that U.S. interest rates are 6 percent, while British interest rates are 7 percent. If the international Fisher effect holds and is used to determine the future spot rate, the forecast would reflect an expectation of:

A) appreciation of the pound's value over the next year.
B) depreciation of the pound's value over the next year.
C) no change in the pound's value over the next year.
D) There is not enough information to answer this question.

Question 65

If the one-year forward rate for the euro is $1.07, while the current spot rate is $1.05, the expected percentage change in the euro is ____ percent.

A) 1.90
B) 2.00
C) -1.87
D) None of these are correct.

Question 66

If a particular currency of a developed country is consistently declining substantially over time, then a market-based forecast of that currency will usually have:

A) underestimated the future exchange rates over time.
B) overestimated the future exchange rates over time.
C) forecasted future exchange rates accurately.
D) forecasted future exchange rates inaccurately but without any bias toward consistent underestimating or overestimating.

Question 67

If an MNC invests excess cash in a foreign county, it would like the foreign currency to ____; if an MNC issues bonds denominated in a foreign currency, it would like the foreign currency to ____.​

A) ​appreciate; depreciate
B) ​appreciate; appreciate
C) ​depreciate; depreciate
D) ​depreciate; appreciate

Question 68

A regression model was applied to explain movements in the Canadian dollar's value over time. The coefficient for the inflation differential between the United States and Canada was 0.2. The coefficient of the interest rate differential between the United States and Canada produced a coefficient of 0.8. Thus, the Canadian dollar depreciates when the inflation differential ____ and the interest rate differential ____.

A) increases; increases
B) decreases; increases
C) increases; decreases
D) decreases; decreases

Question 69

Which of the following is not one of the major reasons for MNCs to forecast exchange rates?

A) to decide in which foreign market to invest excess cash
B) to decide where to borrow at the lowest cost
C) to determine whether to require a subsidiary to remit funds or invest them locally
D) to speculate on exchange rate movements

Question 70

Sensitivity analysis allows for all of the following except:

A) accountability for uncertainty.
B) focus on a single point estimate of future exchange rates.
C) development of a range of possible future values.
D) consideration of alternative scenarios.

Question 71

Foreign exchange markets are generally found to be at least ____ efficient, which implies that all public information is considered within the markets.

A) weak-form
B) semistrong-form
C) purchasing power purity form
D) None of these are correct.

Question 72

If both interest rate parity and the international Fisher effect hold, then between the forward rate and the spot rate, the ____ rate should provide more accurate forecasts for currencies in ____-inflation countries.​

A) ​spot; high
B) ​spot; low
C) ​forward; high
D) ​forward; low

Question 73

Factors such as economic growth, inflation, and interest rates are an integral part of ____ forecasting.

A) technical
B) fundamental
C) market-based
D) None of these are correct.

Question 74

If today's exchange rate reflects all relevant public information about the euro's exchange rate, but not all relevant private information, then ____ would be refuted.

A) weak-form efficiency
B) semistrong-form efficiency
C) strong-form efficiency
D) weak-form efficiency AND semistrong-form efficiency
E) semistrong-form efficiency AND strong-form efficiency

Question 75

Silicon Co. has forecasted the Canadian dollar for the most recent period to be $0.73. The realized value of the Canadian dollar in the most recent period was $0.80. Thus, the absolute forecast error as a percentage of the realized value was ____ percent.​

A) ​9.6
B) ​-9.6
C) ​8.8
D) ​-8.8

Question 76

The following regression model was estimated to forecast the percentage change in the Australian dollar (AUD): ​
AUD_t = a₀ + a₁INT_t + a₂INF_{t - 1} + $\mu$ _t,
​
Where AUD is the quarterly change in the Australian dollar, INT is the real interest rate differential in period t between the United States and Australia, and INF is the inflation rate differential between the United States and Australia in the previous period. Regression results indicate coefficients of a₀ = .001; a₁ = -.8; and a₂ = .5. Assume that INF_{t - 1} = 4%. However, the interest rate differential is not known at the beginning of period t and must be estimated. You have developed the following probability distribution:
​
Probability
Possible Outcome
20%
-3%
80%
-4%
​
There is a 20 percent probability that the Australian dollar will change by ____, and an 80 percent probability it will change by ____.

A) 4.5 percent; 6.1 percent
B) 6.1 percent; 4.5 percent
C) 4.5 percent; 5.3 percent
D) None of these are correct.

Question 77

Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro: euro_t
= b₀ + b₁INF_{t - 1} + b₂INC_{t - 1}
​
= )005 + .9INF_{t - 1} + 1.1INC_{t - 1}
​
The most recent quarterly percentage change in the inflation differential between the United States and Europe was 2 percent, while the most recent quarterly percentage change in the income growth differential between the United States and Europe was -1 percent. Based on this information, the forecast for the euro is a(n) ____ of ____ percent.

A) appreciation; 3.4
B) depreciation; 3.4
C) appreciation; 0.7
D) appreciation; 1.2

Question 78

The U.S. inflation rate is expected to be 4 percent over the next year, while the European inflation rate is expected to be 3 percent. The current spot rate of the euro is $1.03. Using purchasing power parity, the expected spot rate at the end of one year is $____.

A) 1.02
B) 1.03
C) 1.04
D) None of these are correct.

Question 79

Monson Co., based in the United States, exports products to Japan denominated in yen. If the forecasted value of the yen is substantially ____ than the forward rate, Monson Co. will likely decide ____ the payments.

A) higher; to hedge
B) lower; not to hedge
C) higher; not to hedge
D) None of these are correct.

Question 80

Which of the following is true according to the text?

A) The forecast bias of a currency rarely shifts over time.
B) The absolute forecast error as a percentage of the realized value is a good measure to use in detecting a forecast bias.
C) Forecasting errors are smaller when focused on longer term periods.
D) None of these are correct.