Foreign Exchange Rate Determination and Forecasting OR Luck Favors the Prepared

1. Foreign Exchange Rate Determination and Forecasting OR �Luck Favors the Prepared�

2. Foreign Exchange Rate Determination and Forecasting: Learning Objectives Examine how the supply and demand for any currency can be viewed as an asset choice issue within the portfolio of investors Explore how the three major approaches to exchange rate determination � parity conditions, the balance of payments, and the asset approach � combine to explain in the numerous emerging market currency crises experienced in recent years Observe how forecasters combine technical analysis with the three major theoretical approaches to forecasting exchange rates

3. Foreign Exchange Rate Determination and Forecasting Three basic approaches Parity conditions Balance of Payments Asset market These are not competing theories but are in fact complimentary theories Without the depth and breadth of the various approaches combined, our ability to capture the complexity of the global market for currencies is lost

4. Foreign Exchange Rate Determination and Forecasting Along with an understanding of the theories, an understanding of the complexities of international political economy, societal and economic infrastructures, and random political and social events is needed when viewing the foreign exchange markets Infrastructure weaknesses were among the major causes of the exchange rate collapses in emerging markets in the late 1990s Speculation contributed greatly to the emerging market crises. Uncovered interest rate arbitrage caused by extremely low interest rates in Japan coupled with high real interest rates in the US was a problem in the 1990s

5. Foreign Exchange Rate Determination and Forecasting Cross-border foreign direct investment and international portfolio investment into emerging markets dried up during the recent crises Foreign political risks have been much reduced in recent years as capital markets became less segmented from each other and more liquid Finally, note that most determinants of spot exchange rates are also in turn affected by changes in the spot rate � in other words, they are not only linked but mutually determined