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Future Exchange Risks
Introduction
Fundamental forecasting predicts the future exchange rates on the basis of trends in the
economic variables. The managers in the company can make use of econometric model by
feeding the data to get the more subjective analysis. Technical forecasting uses the past trends in
the exchange rates to determine the future trends in the rates. It presumes that the current
exchange rates reflect all the facts in the market and future rates will follow the same patterns
under similar circumstances. The researchers say that forecasting is imprecise and the past
movements of the exchange rates cannot be used to predict future movements. It is extremely
important for the CFO of the company to learn to deal biases that turn the direction forecasting
exchange rates.
Discussion
The major biases include, overreaction to the unexpected news events, illusory
correlation, focusing on the subset of the information at the expense of overall set of information,
inability to learn from the past mistakes and overconfidence on the ability to forecast currencies
accurately. The factors like timing, magnitude and direction of the exchange rate attributes to
determine the forecast exchange rates accurately. The CFO or the managers of the company
needs to understand these concerns to their way to determine the accurate exchange rates. In the
current example, the company mostly dealing with the currency Euro, which is pretty much float
freely without any government intervention. So CFO can predict timing and direction of the
change can be predicted, however, it is difficult to predict the magnitude of the exchange rate
forecast (Daniels et al., 2011). The freely floating currencies like Euros, it is bit easy to predict
the exchange rate forecast for the CFO or the managers of the company. The best predictors of
the future exchange rates are interest rates for short-term movements, medium-term movements
of inflation and current balances for long-term movements. It is necessary for CFO of the
company to monitor the same key factors that US government follows to try to predict the
exchange rate and market value (McNeil, 2015). The key factors include institutional setting,
fundamental analysis, confidence factors events and technical analysis. There are many
significant business implications of exchange rate changes in the companys marketing,
production and financial decisions (Bruno, 2015).
The FOREX market is a trading currencies. Currencies are quoted in pairs, such as GBP /
USD, USD / CHF, etc. The first currency listed is called the "base". The second currency listed is
called the "quote currency". For example, if you believe that the Canadian government will
weaken its currency (CAD - Canadian dollar) in order to help the export sector, buy USD / CAD
(in terms of trading: GO long). Because there is a want to own US dollars while they value
against the Canadian dollar (Mancini, 2013).
On the other hand, if it is believed that due to the instability of the US economy the dollar
will lose value, you will run a sale on USD / CAD (in terms of trading: GO short). By doing so,
you will have sold US dollars in the expectation that they will depreciate against the Canadian
dollar. In the Forex market can first buy to sell later more expensive, or sell first and then buy it
cheaper. The question of price going up or down does not matter. The important thing is that the
direction of a transaction is the same as the price! Traders use different techniques that allow a
greater or lesser degree of effectiveness, predict where the price will in the future. The range of
instruments used for market analysis is very broad (Bonetti, 2012)
Similar to the Stock Exchange, to operate the FOREX investor should be registered in a
broker (broker). Customers can open their purchase or sale through an online platform offered by
the broker (home broker) which will have instant execution of their operations. All this happens
with a click of your mouse in the comfort of your home. No matter what your style to operate the
market. FOREX can be operated using. News, analysis, fundamentals, economic indicators and
technical analysis Through the internet, all buy and sell orders are executed in seconds anytime,
within its own system operating platform, where each broker (broker) has been offering more
and more advantages in terms of advanced technology and competitiveness. And you can operate
both in high and in low, without the inconvenience of having to rent any asset, such as the Stock
Exchange (Sarno, 2012).
Marketing decisions
The currency changes can produce the opportunities for the companies and the same time
they can be bad for the growth of the company. The exchange rates can affect the demand for the
companys products at a home and abroad. For instance, in early 2008, the euro was surging
against U.S dollar, companies in Europe ware facing tough time in exporting goods to abroad,
and conversely U.S companies were benefited by the week currency as companies in U.S
doubled their exports, and tried to control the slowness in the domestic market. Therefore, the
strengthening of the countrys currency value would result in weak export of the goods abroad
(Jacque, 2013)
Production decisions
Exchange-rate changes can affects the production decisions. A manufacture company in
the country, where its operating costs and labor wages are expensive, would like to relocate the
production to the country with currency with the currency rapidly losing. The native countrys
currency may help in buying lots of weaker currency for initial production setups. The goods
manufactured in the country become relatively cheap in the market. For instance, if the Euro
continues to remain strong against U.S dollar, BMW would make the strategy to increase its
manufacturing capacity in the United States to take advantage of the cheaper dollar
(Hodrick, 2014).
Financial Decisions
Exchange rates can affect financial decisions in terms of sourcing financial resource, the
cross-border remittance of funds and the reporting of the financial results. In sourcing financial
resource, the company may plan to borrow the loan from the country where interest rates are low.
However, interest rates differences will be compensated for the money in the market through
exchange rates. Companies may try to maximize the returns by converting local currency into its
own home country currency, however, the countries with weak currencies often have currency
controls, making difficulties for companies to do so. The exchange rates can influence on the
reporting of the financial reports. In an example, united technologies, a U.S based elevator and
aerospace manufacturer reported every penny the euro increases against dollars and ends up in
extra $10 million profits (Moore, 2013).
.
and country and liquidity risk just to name a few can be damaging to a market portfolio, but if
done right can bring extensive profits to an investor portfolio (Hodrick, 2014).
All contributing factor to a net inflow of foreign currency (the overall balance surplus) is
a net demand of the national currency against foreign currencies and leads to an
appreciation of that.
All contributing factor to a net outflow of foreign exchange (the overall balance deficit) is
a net demand for foreign currency against national currency and this leads to a
depreciation.
The determinants fundamentals of the exchange rate in the following order: first, the
exchange of goods and services; then the purchasing power parity; finally, the parity of interest
rates. This is an order of didactic presentation. Subsequently, reordenaremos according to time,
that is, in terms of the factors determining the short, medium and long term. Other than that the
approaches based on expectations foreign exchange market participants and exchange rate
policy. The exchange of goods or merchandise, that is, the balance of trade balance, is not the
main determinant of the exchange rate?
Indeed, it is intuitive that foreign purchases provoke the need for foreign exchange. Vice
versa, foreign sales provide increased supply of foreign currencies. A first determinant of the
exchange rate would therefore be the external trade in goods or goods given by the difference
between exports and imports (X - M). Deepening a bit analysis, it appears that domestic activity
levels of Y and Y * foreign affect this difference. If the growth of the rest of the world (Y *) is
greater than the inner (Y), the difference (Y * - Y) is likely to result in an export (X) greater than
the sum of imports (M): X - M> 0. O surplus of current account balance of payments, causes an
appreciation of the national currency in the foreign exchange market. Conversely, a domestic
growth (Y) faster than foreign growth (Y *) may lead to a deficit in the trade balance
(X - M <0) and a consequent depreciation of the national currency (+ e) (Chen, 2013).
The Theory of Purchasing Power of Parity see the price movements for domestic and
foreign goods the key determinant of the exchange rate. There are two versions of this theory:
in a competitive international market without barriers to trade and without transportation costs
and transaction. In other words, we are required extremely restrictive conditions for its validity:
substitute goods), its domestic price (P) must be identical to its foreign price (P *) after
conversion at the exchange rate (e):
And P = P * = P or E / P *. This would be due to competition and arbitration rational
agents: If P> and P *, no one would buy in the country and everyone would buy out (and vice
versa P <and P *) to P = e P *. Of course this would only be possible if the internal and external
prices were flexible or a floating exchange rate regime (Bansal, 2012).
According to this law of one price, a single currency can not have a different purchasing power
in both countries, those perfect competitive conditions. All purchases will be made where
purchasing power is highest.
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An example of the parity in interest rates occur when there was a high of US interest rate
(i *) with respect to Brazilian interest rate (i) and she attracted Brazilian capital to the United
States. Brazilian investors buy dollars in cash, to apply them in the United States. This additional
demand for dollars in the Brazilian foreign exchange market, would lead to the appreciation of
the American currency. Remember that the high exchange rate corresponds to a depreciation of
the Brazilian currency. If there was a similar phenomenon in the rest of the world, the net inflow
of capital in the United States could even lower your interest rate (Anzuini, 2012).
The formula of non-covered parity of interest rates (no currency hedging in the futures
market) is: i - (i * + ) = 0 or = i - i *. The caret (^) over a variable means that it is an
expectation. Thus it is expressed the percentage of the anticipated change in the exchange rate :
is = (e t - and 0 ) / e 0 .
i * = i => is = 0. The depreciation rate of the national currency is zero, ie, there is no
expectation of variations in the exchange rate for the period, due to the parity of interest
rates (Frenkel, 2013).
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i *> i => (i - i *) <0. In this case, Brazilian investors have to anticipate, with the possible
escape of capital, depreciation of the national currency and appreciation of foreign
currency. The higher purchase cost of foreign currency will have to be deducted from
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