tunities for certain currencies during specified periods (for example, by the use of
“filter rules “). However it is also logical to suppose that speculators will bear foreign
exchange risk only if they are compensated with a risk premium. Are the above zero
expected returns excessive in a risk-adjusted sense? Given the small size of the bias
in the forward exchange market and the magnitude of daily currency fluctuations, the
answer is “probably not.”
As a result of their finding that the foreign exchange markets are among the
world’s most efficient, academics argue that exchange rate forecasting by corpora-
tions, in the sense of trying to beat the market, plays a role only under very special
circumstances. Indeed, few firms actively decide to commit real assets in order to
take currency positions. Rather, they get involved with foreign currencies in the
course of pursuing profits from the exploitation of a competitive advantage. Instead
of being based on currency expectations, this advantage is based on expertise in such
areas as production, marketing, the organization of people, or other technical re-
sources. If someone does have special expertise in forecasting foreign exchange
rates, such skills can usually be put to use without incurring the risks and costs of
committing funds to other than purely financial assets. Most managers of nonfinan-
cial enterprises concentrate on producing and selling goods; they should find them-
selves acting as speculative foreign exchange traders only because of an occasional
opportunity encountered in the course of their normal operations.
Only when foreign exchange markets are systematically distorted by government
controls on financial institutions do the operations of trading and manufacturing firms
provide an opportunity to move funds and gain from purely financial transactions.
Exhibit 6.9 offers a flowchart of criteria for forecasting and hedging decisions.
Forecasting exchange rate changes, however, is important for planning purposes.
To the extent that all significant managerial tasks are concerned with the future, an-
ticipated exchange rate changes are a major input into virtually all decisions of en-
terprises involved in and affected by international transactions. However, the task of
forecasting foreign exchange rates for planning and decision-making purposes, with
the purpose of determining the most likely exchange rate, is quite different from at-
tempting to beat the market in order to derive speculative profits.
Expected exchange rate changes are revealed by market prices when rates are free
to reach their competitive levels. Organized futures or forward markets provide in-
expensive information regarding future exchange rates, using the best available data
and judgment. Thus, whenever profit-seeking, well-informed traders can take posi-
tions, forward rates, prices of future contracts, and interest differentials for instru-
ments of similar risk (but denominated in different currencies) provide good indica-
tors of expected exchange rates. In this fashion, an input for corporate planning and
decision making is readily available in all currencies where there are no effective ex-
change controls. The advantage of such market-based rates over “in-house” forecasts
is that they are both less expensive and more likely to be accurate. Those who tend
to have the best information and track record determine market rates; incompetent
market participants lose money and are eliminated.
The nature of this market-based expected exchange rate should not lead to con-
fusing notions about the accuracy of prediction. In speculative markets, all decisions
are made on the basis of interpretation of past data; however, new information sur-
faces constantly. Therefore, market-based forecasts rarely will come true. The actual
price of a currency will either be below or above the rate expected by the market. If
the market knew which would be more likely, any predictive bias quickly would be
6 • 22 MANAGEMENT OF CORPORATE FOREIGN EXCHANGE RISK