Currency ForecastingRMB to GBP

CURRENCY FORECASTING IN IB• Hedging decision• Short-term financing decision• Short-term investment decision• Capital budgeting decision• Earnings assessment• Long-term financing decision

Source: Madura

METHODS OF CURRENCY FORECASTING

• Fundamental Analysis

• Technical Analysis Relies on historical price patterns to arrive at a forecast. Simple Moving Average (SMA), Exponential Moving Average (EMA), Chartism

Examines economic relationships and financial data to arrive at a forecast. Ex: Parity Models, Econometric Models etc.

PARITY MODELS

– Through these models one attempts to calculate an “equilibrium” exchange rate in the future.

– Analysis built on “long standing” economic theories of exchange rate determination.• Purchasing Power Parity Model• International Fisher Effect

PURCHASING POWER PARITY MODEL

• Follow the Law of One Price. • Assumes that exchange rates will change to offset relative prices levels between

countries.– Countries with relatively high rates of inflation will show currency depreciation– Countries with relatively low rates of inflation will experience currency

appreciation• In equilibrium, the amount of depreciation (or appreciation) will be equal to the

inflation differential.• Provide results based on inflation rate, spot rate and time

PPP FORECASTING

• Future Spot rate (et) = Spot Rate (e0) x • The Spot rate of GBP/RMB at 20 December 2013 was 9.91412• According to World Bank data the inflation of rate of both country in

2013 was 2.6%• So Based on this concept the spot rate of 19 December 2014 will be

9.91412

Source: The World Bank 2013 & XE 2014

INTERNATIONAL FISHER EFFECT

The exchange rates change in direct proportion to relative differences in long term interest rates.– The long term interest rates capture the market’s expectation for inflation.– Countries with relatively high rates of long term interest rates (i.e., high

inflation) will show currency depreciation.– Countries with relatively low rates of long term interest rates (i.e., low

inflation) will show currency appreciation.• In equilibrium, the amount of depreciation (or appreciation) will be equal to

the long term interest rate differential.

IFE Forecasting

• The interest rate of the people’s Bank of China and bank of England are 5.60% and 0.50%

• Spot GBP/RMB = 9.91412 (on 20 December 2013)• IFE Spot GBP/RMB Forecast– 1 year change in GBP = 9.91412x (5.60%-0.50%)= 0.50562– 1 year spot GBP = 9.91412 + 0.50562 = 10.41974

Source: Global Rate 2013, Bank of England 2014

TECHNICAL ANALYSIS

• Uses charts and price patterns to forecast future moves in spot exchange rates.– Looks for price patterns that have historically signed a future move.– Assume historical relationship will result in similar moves in the

future. • Not interested in “explaining” the source of the expected future move.– Not interested in financial information or news.

SIMPLE MOVING AVERAGE

Sep 13 Oct 13 Nov13 Dec 13 Jan 14 Feb 14 Mar 14 Apr 14 May 14 Jun 14 Jul 14 Aug 14 Sep 14 Oct 14 Nov 14 Dec 14

9.798 9.860 9.811 9.914 9.945 10.130 10.280 10.453 10.502 10.589 10.603 10.192 10.013 9.851 9.598

10.173 10.191 10.19 10.172

The simple moving average is extremely popular for currency forcasting, but like all technical indicators, it does have its critics. Many individuals argue that the usefulness of the SMA is limited because each point in the data series is weighted the same, regardless of where it occurs in the sequence.

N.B: All the rate taken on 20 or 19 of each month

Source: Investopedia 2014, XE.com 2014

EXPONENTIAL MOVING AVERAGE• The exponential moving average is a type of moving average that gives

more weight to recent prices in an attempt to make it more responsive to new information.

• Current EMA= ((Price(current) - previous EMA)) X multiplier) + previous EMA

Sep 13 Oct 13 Nov13 Dec 13 Jan 14 Feb 14 Mar 14 Apr 14 May 14

Jun 14 Jul 14 Aug 14 Sep 14 Oct 14 Nov 14 Dec 14

9.798 9.860 9.811 9.914 9.945 10.130 10.280 10.453 10.502 10.589 10.603 10.192 10.013 9.851 9.598

10.173 10.191 10.190 10.172

10.173 10.125 10.046

Here Multiplier= (2/12+1)

Source: Investopedia 2014

CHARTISM

Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-149

9.2

9.4

9.6

9.8

10

10.2

10.4

10.6

10.8

RMB/GBPActual Rate SMA EMA

Source: XE.com 2014

EXCHANGE RATE

Q

P

Q

P

P1 P1

Q1 Q1

S

D

D1

Q2

P2

Increase Demand

D

P2

Q2

D2

S

Decrease Demand

EXCHANGE RATE

Q

P

P1

Q1

S

D

S1

P2

Q2Q

P

P1

Q1

D

S

S1

P2

Q2

Increase Supply Decrease Supply

EXCHANGE RATE

• Tourism supply lead to appreciation to the exchange rate.

• Overseas goods compare to domestics goods could lead to increase in a supplier to a RMB exchange rate if the interest rate services seasons at attractive in the demand for currency

CONCLUSION

• Different System of currency forecasting providing different value.• The more information about different economic factors provide more

reliable forecasting.• Fundamental analysis use more economical factors• Technical analysis use more market pricing trend.

REFERENCE• Shapiro, A.C. 2010, Multinational financial management, John Wiley, Hoboken, N.J.• BANK OF ENGLAND (2014). Bank of England. [online]. Last accessed 09 December 2014 at:

http://www.bankofengland.co.uk/Pages/home.aspx• [online]. Last accessed 9 December 2014 2014 at: http://www.global-rates.com/interest-rates/central-

banks/central-bank-china/pbc-interest-rate.aspx• INVESTOPEDIA (2014). Investopedia. [online]. Last accessed 08 December 2014 at:

http://www.investopedia.com/articles/trading/10/simple-exponential-moving-averages-compare.asp• INVESTOPEDIA (2014). Investopedia. [online]. Last accessed 09 December 2014 at:

http://www.investopedia.com/articles/forex/11/4-ways-to-forecast-exchange-rates.asp• [online]. Last accessed 8 December 2014 at: http://abeweb.org/proceedings/proceedings06/sandler.pdf• THE WORLD BANK (2014). The World Bank. [online]. Last accessed 08 December 2014 at:

http://data.worldbank.org/indicator/FP.CPI.TOTL.ZG• XE (2014). XE.com. [online]. Last accessed 08 December 2014 at:

http://www.xe.com/currencycharts/?from=GBP&to=CNY&view=2Y