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3. Gary Co. has forecasted the CAD for the most recent period to be $0.73. The realized value of the CAD in the most recent period was $0.80. Compute the absolute forecast error as a percentage of the realized value. Briefly explain key methods used for forecasting future exchange rates. 15 points
Expert Solution
3). Absolute forecast error as a percentage of the realized value = |forecasted value - realized value|/realized value
= |0.73-0.80|/0.80 = 0.07/0.80 = 8.75%
Some populat methods of forecasting exchange rates are:
1). Purchasing power parity - Assumes that a good in two countries has to be priced such that no arbitrage opportunity exists. In order to do this, exchange rates will change in line with price changes due to inflation.
2). Econometric models - In this, an economic factor which influences the currency is chosen and a forecasting model is created based on that.
3). Relative economic strength - This is a general approach where the overall economy of a country is analyzed and exchange rates are forecast based on that. If, for example, a country is doing well economically then it will attract investments which means demand for currency will increase, resulting in an increase in exchange rate.
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