Chapter 9—Forecasting Exchange Rates
1. Which of the following forecasting techniques would best represent the use of today’s forward
exchange rate to forecast the future exchange rate?
a.
fundamental forecasting.
b.
market-based forecasting.
c.
technical forecasting.
d.
mixed forecasting.
2. Which of the following forecasting techniques would best represent sole use of 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 best represent the use of 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 best represent the sole use of the pattern of
historical currency values of the euro to predict the euro’s future currency value?
a.
fundamental forecasting.
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
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. According to the text, the analysis of currencies forecasted with use of the forward rate suggests that:
a.
currencies exhibited about the same mean forecast errors as a percent of the realized value.
b.
the Canadian dollar can be forecasted by U.S. firms with greater accuracy than other
currencies.
c.
the Swiss franc can be forecasted by U.S. firms with greater accuracy than other
currencies.
d.
none of the above
7. Assume the following information:
Predicted Value of
Realized Value of
Period
New Zealand Dollar
New Zealand Dollar
1
$.52
$.50
2
.54
.60
3
.44
.40
4
.51
.50
Given this information, the mean absolute forecast error as a percentage of the realized value is about:
a.
1.5%.
b.
26%.
c.
6%.
d.
6.5%.
e.
none of the above
= [.04 + .10 + .10 + .02]/4
8. 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 the above
d.
none of the above
9. 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.
10. Which of the following is true according to the text?
a.
Forecasts in recent years have been very accurate.
b.
Use of the absolute forecast error as a percent 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.
11. 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.
12. When the value from the prior period of an influential factor 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
13. 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.
14. Which of the following is not a limitation of fundamental forecasting?
a.
uncertain timing of impact.
b.
forecasts are 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 the above
15. Assume that interest rate parity holds. The U.S. five-year interest rate is 5% annualized, and the
Mexican five-year interest rate is 8% 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.
16. Assume that the forward rate is used to forecast the spot rate. The forward rate of the Canadian dollar
contains a 6% 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 the above
17. 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.
A and B
e.
B and C
18. 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
19. 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.
20. If the forward rate was 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.
21. 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.
22. The following regression model was estimated to forecast the value of the Malaysian ringgit (MYR):
MYRt = a0 + a1INCt − 1 + a2INFt − 1 +
t,
where MYR is the quarterly change in the ringgit, INF is the previous quarterly percentage change in
the inflation differential, and INC is the previous quarterly percentage change in the income growth
differential. Regression results indicate coefficients of a0 = .005; a1 = .4; and a2 = .7. The most recent
quarterly percentage change in the inflation differential is −5%, while the most recent quarterly
percentage change in the income differential is 3%. Using this information, the forecast for the
percentage change in the ringgit is:
a.
4.60%.
b.
−1.80%.
c.
5.2%.
d.
−4.60%.
e.
none of the above
23. 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 U.S. and India, and INF is the inflation rate differential between the U.S. and India in the
previous period. Regression results indicate coefficients of a0 = .003; a1 = −.5; and a2 = .8. Assume
that INFt − 1 = 2%. 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:
Possible Outcome
−2%
−3%
−4%
The expected change in the Indian rupee in period t is:
a.
3.40%.
b.
0.40%.
c.
3.10%.
d.
1.70%.
e.
none of the above
24. Huge Corporation has just initiated a market-based forecast system using the forward rate as an
estimate of the future spot rate of the Japanese yen (¥) and the Australian dollar (A$). Listed below are
the forecasted and realized values for the last period:
Currency
Forecasted Value
Realized Value
Australian dollar
$.60
$.55
Japanese yen
$.0067
$.0069
According to this information and using the absolute forecast error as a percentage of the realized
value, the forecast of the yen by Huge Corp. is ____ the forecast of the Australian dollar.
a.
more accurate than
b.
less accurate than
c.
more biased than
d.
the same as
Absolute forecast error for the Australian dollar = (|.60 − .55|)/.55 = 9.09%
2.90%
25. Gamma Corporation 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 to be 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
26. 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.
27. 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
28. 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
29. 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 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%; today
b.
depreciate by .8%; tomorrow
c.
appreciate by .8%; today
d.
appreciate by .8%; tomorrow
30. 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
31. 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 U.S. and Europe
was 2 percent, while the most recent quarterly percentage change in the income growth differential
between the U.S. and Europe was −1 percent. Based on this information, the forecast for the euro is
a(n) ____ of ____%.
a.
appreciation; 3.4
b.
depreciation; 3.4
c.
appreciation; 0.7
d.
appreciation; 1.2
32. 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
33. 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 ____%.
a.
1.90
b.
2.00
c.
−1.87
d.
none of the above
34. 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
35. 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 spot rate will provide ____ forecasts.
a.
substantial; similar
b.
substantial; very different
c.
close to zero; similar
d.
close to zero; very different
36. 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
37. 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 ____%.
a.
9.6
b.
−9.6
c.
8.8
d.
−8.8
38. 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
39. 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
40. 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
41. MNCs can forecast exchange rate volatility to determine the potential range surrounding their
exchange rate forecast.
a. True
b. False
42. If the pattern of currency values over time appears random, then technical forecasting is appropriate.
a. True
b. False
43. Inflation and interest rate differentials between the U.S. and foreign countries are examples of
variables that could be used in fundamental forecasting.
a. True
b. False
44. A regression analysis of the Australian dollar value on the inflation differential between the U.S. and
Australia produced a coefficient of .8. Thus, for every 1% increase in the inflation differential, the
Australian dollar is expected to depreciate by .8%.
a. True
b. False