International Financial Management
Exam 3 Questions with Accurate
Answers
Chapter 9 - ANSWERS
Why do firms forecast exchange rates? - ANSWERS1. Hedging decisions
2. Capital budgeting decisions
3. Assess earnings
4. Short term investment decisions
5. Long term financing decisions
How can we effectively forecast exchange rates? - ANSWERSForecasting techniques
It is easier to forecast... - ANSWERSshort-term moves in exchange rates
3 forecasting techniques - ANSWERS1. Technical Forecasting
2. Fundamental Forecasting
3. Market-Based Forecasting
Technical Forecasting - ANSWERSBased on historical patterns- looking for trends and
corrections based on what you see in the past
Limitation of technical forecasting - ANSWERSRely on the patterns you see from the
past continuing in the future
Fundamental forecasting - ANSWERSef = f(change in INF, change in INT, change in
INC, change in GC, change in EXP)
Ways to carry out fundamental forecasting - ANSWERS1. Use Purchasing Power
Parity- ef = (1+ Ih/1+ If)
2. Use Lagged Impact
3. Instantaneous Impact- (similar to lagged impact)
4. Comprehensive model- collect historical data for exchange rate movements
Fundamental forecasting uses... - ANSWERSinflation rates
Limitations with fundamental forecasting - ANSWERS1. Precise timing of the impact of
factors on a currency's value is unknown
2. The accuracy of the exchange rate forecast is affected by the accuracy of these
factors (INF, INC, INT)
3. Some factors aren't easily quantified
, 4. Coefficients derived from regression analysis may not remain constant
Market Based Forecasting - ANSWERS1. Use the current spot rate
2. Use the forward rate
3. Use interest rate parity
What kind of forecasting do companies use? - ANSWERSA mix of all three, technical,
fundamental and market based to get an accurate forecast
How to measure the accuracy of the forecast - ANSWERSThe forecast error
Absolute forecast error = (Forecasted value - Realised value) / Realised value
The forecast error... - ANSWERSChanges over time
Varies among currencies
Time horizon and the forecast error - ANSWERSOver a longer period of time expect the
forecast error to be larger
When the point isn't on the line it is a... - ANSWERSforecast bias
Chapter 10 - ANSWERS
Why do MNCs care about exchange rate risk? - ANSWERSIf MNCs can protect their
operations from this exposure they can reduce the risk that the stock valuation may
decline, and can also increase its ability to repay its debt over the long run, meaning it
can reduce the possibility of failure and allowing the MNC to borrow more funds at a
lower cost
Arguments for why exchange rate risk is irrelevant for MNCs - ANSWERS1. An MNC
with cash flows in numerous currencies should not be affected by exchange rate risk if
the adverse effects due to some currency movements are offset by the favourable
effects of other currency movements
2. If stakeholders have stakes in a well-diversified portfolio of MNCs, then the portfolio's
value is insulated against adverse effects
3. Investors who invest in MNCs can hedge exchange rate risk on their own
Arguments for why exchange rate risk is relevant for MNCs - ANSWERS1. Exchange
rate effects on an MNC will not be offsetting, because many currency's exchange rate
movements are in the same direction
2. Many MNCs are similarly affected by exchange rate movements, so it would be
difficult to create a diversified portfolio that insulates from exchange rate risk
3. Investors who invest in MNCs don't have complete information on MNCs exposure to
exchange rate fluctuations, so can't hedge the exposure of their individual investments,
so because MNCs are more informed about their exposure they have more expertise in
hedging risk
Exam 3 Questions with Accurate
Answers
Chapter 9 - ANSWERS
Why do firms forecast exchange rates? - ANSWERS1. Hedging decisions
2. Capital budgeting decisions
3. Assess earnings
4. Short term investment decisions
5. Long term financing decisions
How can we effectively forecast exchange rates? - ANSWERSForecasting techniques
It is easier to forecast... - ANSWERSshort-term moves in exchange rates
3 forecasting techniques - ANSWERS1. Technical Forecasting
2. Fundamental Forecasting
3. Market-Based Forecasting
Technical Forecasting - ANSWERSBased on historical patterns- looking for trends and
corrections based on what you see in the past
Limitation of technical forecasting - ANSWERSRely on the patterns you see from the
past continuing in the future
Fundamental forecasting - ANSWERSef = f(change in INF, change in INT, change in
INC, change in GC, change in EXP)
Ways to carry out fundamental forecasting - ANSWERS1. Use Purchasing Power
Parity- ef = (1+ Ih/1+ If)
2. Use Lagged Impact
3. Instantaneous Impact- (similar to lagged impact)
4. Comprehensive model- collect historical data for exchange rate movements
Fundamental forecasting uses... - ANSWERSinflation rates
Limitations with fundamental forecasting - ANSWERS1. Precise timing of the impact of
factors on a currency's value is unknown
2. The accuracy of the exchange rate forecast is affected by the accuracy of these
factors (INF, INC, INT)
3. Some factors aren't easily quantified
, 4. Coefficients derived from regression analysis may not remain constant
Market Based Forecasting - ANSWERS1. Use the current spot rate
2. Use the forward rate
3. Use interest rate parity
What kind of forecasting do companies use? - ANSWERSA mix of all three, technical,
fundamental and market based to get an accurate forecast
How to measure the accuracy of the forecast - ANSWERSThe forecast error
Absolute forecast error = (Forecasted value - Realised value) / Realised value
The forecast error... - ANSWERSChanges over time
Varies among currencies
Time horizon and the forecast error - ANSWERSOver a longer period of time expect the
forecast error to be larger
When the point isn't on the line it is a... - ANSWERSforecast bias
Chapter 10 - ANSWERS
Why do MNCs care about exchange rate risk? - ANSWERSIf MNCs can protect their
operations from this exposure they can reduce the risk that the stock valuation may
decline, and can also increase its ability to repay its debt over the long run, meaning it
can reduce the possibility of failure and allowing the MNC to borrow more funds at a
lower cost
Arguments for why exchange rate risk is irrelevant for MNCs - ANSWERS1. An MNC
with cash flows in numerous currencies should not be affected by exchange rate risk if
the adverse effects due to some currency movements are offset by the favourable
effects of other currency movements
2. If stakeholders have stakes in a well-diversified portfolio of MNCs, then the portfolio's
value is insulated against adverse effects
3. Investors who invest in MNCs can hedge exchange rate risk on their own
Arguments for why exchange rate risk is relevant for MNCs - ANSWERS1. Exchange
rate effects on an MNC will not be offsetting, because many currency's exchange rate
movements are in the same direction
2. Many MNCs are similarly affected by exchange rate movements, so it would be
difficult to create a diversified portfolio that insulates from exchange rate risk
3. Investors who invest in MNCs don't have complete information on MNCs exposure to
exchange rate fluctuations, so can't hedge the exposure of their individual investments,
so because MNCs are more informed about their exposure they have more expertise in
hedging risk
