Question

What are the three most important exchange rate influences for forecasting the future direction of exchange rates? (briefly explain each)

Why would these forecasts be vital to a multinational’s CFO?

Answer 1

The three biggest influencers of currency exchange rates are the interest rate(in the two countries of which exchange ate are being considered), the inflation in the two countries and capital flows/balance of payments/current account deficits.

Inflation and Interest Rates are related to currency exchange rate through the fact thate country with higher inflation and interest rate would see its currency depreciating (losing value) over a period of time. Capital Outflow or a Balance of Payment deficit or Current Account deficits should also see the home currency depreciating owing to the high demand of the foreign currency relative to it,

An MNC has businesses in multiple foriegn countries generating profits in a variety of currencies. It also generates expenses in a variety of currencies. In order to hedge or protect oneself against fluctuating currency exchange rate and consequently fluctuating expenses and incomes, it is important for the CFO to know future exchange rates with some amount of certainty.