Question

A) Mr. Logan expects that British inflation will rise substantially in the future. In previous years when the British inflation was high, the pound depreciated. The prevailing British interest rate is slightly higher than the prevailing U.S. interest rate. The pound has risen slightly over each of the last several months. Mr. Logan wants you to forecast the value of the pound for each of the next 20 months. You explain to him that this will result in an additional fee, but that your firm will explain how the extra service would work?

1. Explain how you can use technical forecasting to forecast the future value of the pound. Based on the information provided, do you think that a technical forecast will predict future appreciation or depreciation in the pound?

2. Explain how you can use fundamental forecasting to forecast the future value of the pound. Based on the information provided, do you think that a technical forecast will predict future appreciation or depreciation in the pound?

3. Explain how you can use market-based forecasting to forecast the future value of the pound. Based on the information provided, do you think that a technical forecast will predict future appreciation or depreciation in the pound?

4. Does it appear that all of the forecasting techniques will lead to the same forecast of the pound’s future value? Which technique would you prefer to use in this situation?

Answer 1

1.) Due to high inflation, The price of exported goods increases in international market such that the demand for them decreases as general public will prefer to consume relatively cheaper goods in comparison to them. Government will increase the interest rate in order to attract the foreign investment such that the domestic currency exchange rate will increase due to high demand of domestic investment.

The past data of future pound rates will be used to do time series analysis such that the company will remove trends and seasonality effect to make the data stationary and then fit a model that will help to forecast the future pound rate.

technical forecast will predict the future appreciation rate and depreciation rate if the past data shows trends .

2.) Fundamental analysis is used to predict future exchange rates by using the past exchange ratios between domestic currency and foreign currency. The following steps need to be followed in order to fit a model

a.) Selection a model such as Purchasing power parity used to generate the forecasts

b.) Estimation of model values required past data such as inflation index of U.K pound and U.S dollars for consecutive periods

Technical forecast will results in forecast error and the U.K pound rate will be estimated at the point where forecasted error between actual exchange rate index and estimated exchange rate index .

3.) Market based forecasting involves using spot exchange rate and forward exchange rate to calculate the pound exchange rate . Under market based forecasting the appreciation and deprication in exchange rate cannot be calculated as the spot exchange rate uses the current currency exchange to calculate the current amount of the contract in international market.

4.) I would suggest to use the technical forecasting as it removes the future trends and oscialtion to calculate the future exchange rate of pound and calculate the appreciation and deprication of currency exchange rate.