1. FINA 7386 – CASE 1 Ntianu Okam Ntianu Okam Chiedu Osuno Chiedu Osuno Ben Tuan Ben Tuan

2. FORECAST MODELS  PPP  FORWARD EXCHANGE RATES  MONETARY APPROACH  AD-HOC ECONOMIC MODELS

3. CURRENCIES  USD  GBP  DEM  JPY  PESO  KOW

4. MODEL ANALYSIS  PPP PROCESS – Based on law of one price –Issues  Ignores financial transactions  Absence of costs  Assumes prices and exchange rates flexible

5. Relative PPP  Weaker version of Absolute PPP  Takes costs into account  Used to calculate the cost of Currency –Depreciates to PPP = overvalued –Appreciates to PPP = undervalued

6. Why use PPP  Stable Long Run Predictions  PPP Exchange rates are better predictors of economic fundamentals across countries

7.  FORWARD EXCHANGE RATES Otherwise known as expectation hypothesis. Is not a regression model.

8.  MONETARY APPROACH States that Fx rates are asset prices traded in efficient markets States that Fx rates are asset prices traded in efficient markets

9.  AD-HOC MODEL –A fundamental approach to forecasting exchange rates. –Based on fundamental economic variables –Further modified through statistical means –It is a mixture of art and science

10. RESULTS COMPARED - GBP Mean Avg. Error – out of sample T-stat R2R2R2R2 PPP0.5584 Not a regression model Forward exchange 0.2649 Not a regression model Monetary asset 0.0509 Refer to worksheet 5% 5% Ad-Hoc model 0.0559 Refer to worksheet 5%

11. RESULTS COMPARED - JPY Mean Avg. Error – out of sample T-stat R2R2R2R2 PPP0.0016 Not a regression model Forward exchange 0.00027 Not a regression model Monetary asset 0.0091 Refer to worksheet 1% 1% Ad-Hoc model 0.00028 Refer to worksheet 4% 4%

12. MODEL OF CHOICE  Based on estimated RSQ, t-stat, and MAE, the Ad-hoc model will be the most effective to use.  Ad-Hoc spot rate forecast for 2005.04: GBP1.8078 USD/GBP JPY0.0096 USD/JPY