- Method of Advanced Indicators
Several indicators are used for prediction of exchange rates. One important indicator
widely used is to determine the ratio of country’s reserves to its imports. The reserves
consist of gold, foreign currencies and SDRs.
- User of Forward Rate as Predictor of Future Spot Rate
Some authors believe in the efficiency of markets and consider that forward rates are
likely to be an unbiased predictor of the future spot rate. In other words, the rate of
premium or discount should be an unbiased predictor of the rate of appreciation or
depreciation of a currency.
Economic approach takes into consideration, Structure of the balance of payments,
Examination of reserves in gold or in foreign exchange, Comparative study of inflation
rates, and Study of activity and employment level, to forecast the exchange rate in the
long run.
- Risks in International Operations
Exchange Rate Risk Assessment And
Internal Techniques of Hedging
Exchange rate risk (ERR) is inherent in the businesses of all multinational enterprises as
they are to make or receive payments in foreign currencies. This risk means eventual
losses incurred by these enterprises due to adverse movements of exchange rates between
the dates of contract and payment. However, ERR does not imply that it will result into
losses only. Gains may also accrue if the movement of rates is favorable.
In view of the substantial and significant stake in foreign countries, foreign exchange risk
has become an integral part of the management activities of any multinational enterprise.
Therefore, the management must be aware of the various techniques of dealing with
ERR. Covering the foreign exchange risk is also known as hedging the risk. If a
company in its wisdom does not want to hedge, it tantamount to have the view that the
future movements of exchange rates will be in its favor. On the contrary, the
conservative enterprises may adopt the policy of hedging everything.
Hedging obviously means a certain cost to an enterprise. Suppose the company hedges
the exposure and the forward rates move in favor of the company due to a shift in
economic factors between the dates of invoice and conversion of currency, the company
would suffer or lose on this account.
Covering of exchange rate risk consists in modifying the company’s exchange position in
the exposed currency (ies). Recourse to covering or hedging techniques means a certain
cost to the enterprise, which should define its strategy in this domain and try to foresee
exchange rate fluctuations.