Market participants who use foreign exchange derivatives tend to take positions based on their expectations of future exchange rates. Portfolio managers of financial institutions may take positions in foreign exchange derivatives to hedge their exposure if they anticipate a decline in the value of the currency denominating their stocks. Speculators may take positions in foreign exchange derivatives to benefit from the expectation that specific currencies will strengthen. There are various techniques for forecasting, but no specific technique stands out because most have had limited success in forecasting future exchange rates.
As the value of a currency adjusts to changes in demand and supply conditions, it moves toward equilibrium. In equilibrium, there is no excess or deficiency of that currency. Thus, the initial task is to develop a forecast of specific exchange rates.
Discuss the following:
Discuss the four exchange rates forecasting methods and which you believe is the best to use and why.
Of the factors that affect exchange rates, in your opinion which one has the biggest impact? Why?