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Chapter 09: Forecasting Exchange Rates
1. Which of the following forecasting techniques would be most likely to use today's forward exchange rate to forecast the
future exchange rate?
a.
fundamental forecasting
b.
market-based forecasting
c.
technical forecasting
d.
interval forecasting
2. 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
3. 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
4. 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
Chapter 09: Forecasting Exchange Rates
b.
market-based forecasting
c.
technical forecasting
d.
mixed forecasting
5. If a particular currency is consistently declining substantially over time, then a market-based forecast of a currency in a
developed country 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.
6. 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.
B and C
7. 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
Chapter 09: Forecasting Exchange Rates
b.
fundamental forecast technique
c.
all of the above
d.
none of the above
8. 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 the above.
9. 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 the above.
10. 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.
11. 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.
B and C
12. 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.
13. Which of the following is not a limitation of fundamental forecasting?
a.
uncertain timing of 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
Chapter 09: Forecasting Exchange Rates
e.
none of the above
14. 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
15. 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.
16. 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
Chapter 09: Forecasting Exchange Rates
c.
strong-form efficiency
d.
A and B
e.
B and C
17. According to the text, research generally supports ____ in foreign exchange markets.
a.
weak-form efficiency
b.
semistrong-form efficiency
c.
strong-form efficiency
d.
A and B
e.
B and C
18. 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.
19. 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.
Chapter 09: Forecasting Exchange Rates
d.
the average absolute error from forecasting would equal zero.
20. 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
21. The following regression model was estimated to forecast the value of the Indian rupee (INR):
INRt = a0 + a1INTt + a2INFt − 1 +
t,
where INR is the quarterly change in the rupee, INT is the real interest rate differential in period t between the United
States and India, and INF is the inflation rate differential between the United States and India in the previous period.
Regression results indicate coefficients of a0 = .003; a1 = −.5; and a2 = .8. Assume that INFt − 1 = 2 percent. 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
30%
−2%
40%
−3%
30%
−4%
The expected change in the Indian rupee in period t is:
a.
3.40 percent.
b.
0.40 percent.
c.
3.10 percent.
d.
1.70 percent.
e.
none of the above
22. 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:
St = a0 + a1Ft
−
1 +
t,
where St is the spot rate of the pound in year t and Ft
− 1
is the forward rate of the pound in year t
−
1. 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 the above
23. 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
24. If a foreign currency is expected to ____ substantially against the parent's currency, the parent may prefer to ____ the
remittance of subsidiary earnings.
a.
weaken; delay
b.
weaken; expedite
c.
appreciate; expedite
d.
none of the above
25. 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
26. 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
27. 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.
a.
True
b.
False
28.
Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro:
eurot
= b0 + b1INFt − 1 + b2INCt − 1
= .005 + .9INFt − 1 + 1.1INCt − 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
29. 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 the above
30. 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 the above
31. 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
32. 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
33. 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 the above
34. 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
35. 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 the above
36. 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.
strong-form
d.
all of the above
37. Foreign exchange markets are generally found to be at least ____ efficient.
a.
weak-form
b.
semistrong-form
c.
strong form
d.
none of the above
38. MNCs can forecast exchange rate volatility to determine the potential range surrounding their exchange rate forecast.
a.
True
b.
False
39. If the pattern of currency values over time appears random, then technical forecasting is appropriate.
a.
True
b.
False
Chapter 09: Forecasting Exchange Rates
40. Inflation and interest rate differentials between the United States and foreign countries are examples of variables that
could be used in fundamental forecasting.
a.
True
b.
False
41. A regression analysis of the Australian dollar 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.
a.
True
b.
False
42. The most sophisticated forecasting techniques provide consistently accurate forecasts.
a.
True
b.
False
43. If the forward rate is used as an indicator of the future spot rate, the spot rate is expected to appreciate or depreciate by
