Forecasting Exchange Rates
The CFO can forecast exchange rates by using either of two approaches, fundamental forecasting or technical forecasting. Fundamental forecasting uses trends in economic variables to predict future rates. The data can be plugged into an econometric model or evaluated on a more subjective basis. Technical forecasting uses past trends in exchange rates themselves to spot future trends in rates. Technical forecasters, or chartists, assume that if current exchange rates reflect all facts in the market, then under similar circumstances, future rates will follow the same patterns.
However, research has shown that except in the very short run, past exchange rates are not an accurate predictor of future exchange rates. According to this theory, exchange rate movements are a random walk. The past movement of an exchange rate cannot be used to predict its future movement (Daniels, Radebaugh & Sullivan, 378). Marketing mangers watch exchange rates because they can affect demand for a company’s products at home and abroad. In early 2008, when the euro was surging against the US dollar, Italian companies struggled to export their products abroad. Conversely, US companies were benefitting from a weak US Dollar.
As long as the dollar was falling, US companies were looking closely at export markets as a place to offset the slowdown in the domestic market. Currency changes can create opportunities, and they may pull them back as well (Daniels, Radebaugh & Sullivan, 380). Exchange rate changes can also effect production decisions. A manufacturer in a county where wages and operating expenses are high, might be tempted to relocate production to a country with a currency that is rapidly losing value. The company’s currency would buy lots of weak currency, making the company’s initial investment cheap.
Further, goods manufactured in that country would be relatively cheap in world markets (Daniels, Radebaugh & Sullivan, 378). Finally, exchange rates can affect financial decisions primarily in the areas of sourcing of financial resources, the remittance of funds across national borders, and the reporting of financial results. In the first area, a company might be tempted to borrow money in places where interest rates are lowest. However, recall that the interest rate differentials often are compensated for in money markets through exchange rate changes.
In deciding about cross border financial flows, a company would want to convert local currency into its own home country currency when exchange rates are most favorable, so it can maximize its return. However, countries with weak currencies often have currency controls, making it difficult for MNEs to do so. Also, exchange rate changes can influence the reporting of financial results (Daniels, Radebaugh & Sullivan, 381). References Daniel, J. D. , Radebaugh, Lee H. , Sullivan, Daniel P. , (2011) International Business 13e. Upper Saddle River, New Jersey, Prentice Hall