Question

Go to a source that allows you to assess recent exchange rate movements (such as Yahoo.finance) of JPY/USD trends over the past year (you can use the data you collected for Homework 1.4 for this purpose).

Go to cmegroup.com to obtain the current (making sure to include the date you select) futures price for the JPY and calculate (use the annual percentage formula) whether the JPY is currently trading at a (ANNUALIZED) discount or at a premium to the USD. Make sure to include the specific maturity date of the futures contract you select (try to find one with a maturity date of approximately one year from now). You can use the data you collected for Homework 2.1 for this purpose.

Question 1 - Compare the forecasts for the future movement of the JPY using a “Technical” forecasting approach to what would be predicted using a “Market” forecasting approach. How would you interpret what each type of these two forecasts tells you? Which do you thing is more accurate, and why?

Answer 1

Technical forecasting of future movements of JPY.

Technical forecasting involves the use of historic data to predict the future values. There can be a trend of successive exchange rate adjustments in the same direction that could lead to continuation of that trend. Alternatively there can be trend of average daily change in exchange rate per week over several recent weeks. A trend of higher mean daily exchange rate adjustments on weekly basis can indicate that exchange rate will continue to appreciate in the future.

For example if the JPY appreciates by 1% against the dollar, it experiences 60% of change on the following day. This is given by:

Et+1 = et*(-60%) when et > 1%

Applying this to the current situation where JPY appreciates by 3% against USD. Then tomorrow’s exchange rate will change by:

Et+1 = et*(-60%)

= 3%*(-60%) = -1.8%

What these two methods tell us:

The premise behind these forecasts is that once a pattern has been identified, the next movement of the price can be predicted. Hence the usage of these methods whether technical or market based use of these techniques in a dynamic environment helps in getting a predictable & measurable outcome.

It is essential to understand what the forecasting is to get the best possible results. It must also be performed in an environment where forecasting is acknowledged as critical business function. So that accuracy is emphasized & game playing is minimized.

They can be evaluated by comparing the actual currency values with values obtained by these forecasting methods. Two criterions used are bias & accuracy. When comparing the accuracy of forecasts of two currencies, the absolute error should be divided by realized value of currency to control for differences of relative value of currencies.

Which method is more accurate?

Market based forecasting can be more accurate compared to technical forecasting because it determines the future spot prices of trade able asset. Exchange or interest rates are used to compare the current pricing with future pricing. This method is mainly used for determining the future bond prices.