Chapter 9 Review Questions: Measuring Forecast Accuracy

Chapter 9 Review Questions 4. Measuring Forecast Accuracy

Chapter 9: Review Questions 4. Measuring Forecast Accuracy. You are hired as a consultant to assess a firm’s ability to forecast. The firm has developed a point forecast for two different currencies presented in the following table. The firm asks you to determine which currency was forecasted with greater accuracy.

Yen Actual Pound Actual Period Forecast Yen Value Forecast Pound Value 1 $.0050 $.0051 $1.50 $1. .0048 .0052 1.53 1. .0053 ..55 1. .0055 .0056 1.49 1.. Forecast Error. The director of currency forecasting at Champaign–Urbana Corp. says, “The most critical task of forecasting exchange rates is not to derive a point estimate of a future exchange rate but to assess how wrong our estimate might be.” What does this statement mean? 7. Forecasting Latin American Currencies.

The value of each Latin American currency relative to the dollar is dictated by supply and demand conditions between that currency and the dollar. The values of Latin American currencies have generally declined substantially against the dollar over time. Most of these countries have high inflation rates and high interest rates. The data on inflation rates, economic growth, and other economic indicators are subject to error, as limited resources are used to compile the data. a. If the forward rate is used as a market-based forecast, will this rate result in a forecast of appreciation, depreciation, or no change in any particular Latin American currency? Explain. b. If technical forecasting is used, will this result in a forecast of appreciation, depreciation, or no change in the value of a specific Latin American currency? Explain. c. Do you think that U.S. firms can accurately forecast the future values of Latin American currencies? Explain.

Paper For Above instruction

Forecast accuracy is a critical component of effective financial and currency management. As a consultant tasked with evaluating a firm's forecasting capabilities, it is essential to understand not only the point forecasts generated but also the reliability and potential errors associated with these estimates. In the context of currency forecasting, particularly involving the Yen and the Pound, assessing which currency has been forecasted more accurately involves analyzing forecast errors and understanding the implications of different forecasting methods.

The data provided indicates actual and forecasted currency values across several periods. To determine forecast accuracy, metrics such as Mean Absolute Error (MAE), Root Mean Squared Error (RMSE), or Mean Absolute Percentage Error (MAPE) are typically used. These metrics quantify the deviation of forecasts from actual observed values, allowing comparison across different currencies. For instance, smaller errors indicate higher forecast accuracy. By calculating these errors for both Yen and Pound forecasts, analysts can identify which currency was predicted more accurately. Generally, a currency with consistently smaller forecast errors over multiple periods demonstrates better forecasting performance.

The statement by the director of currency forecasting at Champaign–Urbana Corp. emphasizes that forecasting is not merely about providing a single point estimate but also about understanding the potential magnitude of errors. This highlights the importance of forecast error measurement, confidence intervals, and risk assessment in currency forecasting. It underscores that a forecast can be considered valuable only if the potential error margins are well understood, aiding decision-makers in managing uncertainty.

In the context of Latin American currencies, the economic environment largely influences currency values. The high inflation and interest rates, coupled with declining currency values against the dollar, pose challenges in accurate forecasting. When using market-based forecasts, such as forward rates, the expectation typically is that currencies will depreciate if the forward rate indicates a lower value than the current spot rate, reflecting anticipated depreciation due to economic instability. However, forward rates can sometimes be inaccurate, especially in volatile markets with high inflation and political instability.

Technical analysis involves studying historical price movements and patterns to predict future currency movements. When employing technical forecasting, trends, and patterns are used to determine whether a currency is likely to appreciate, depreciate, or remain stable. Given the economic instability in Latin America, technical analysis might predict continued depreciation if the trend is downward. Nevertheless, the accuracy of technical forecasts depends on the persistence of historical patterns, which can be unreliable in highly volatile markets.

Regarding the ability of U.S. firms to forecast Latin American currencies, the answer is nuanced. Due to high inflation, economic volatility, political instability, and data reliability issues, U.S. firms face considerable challenges in accurately predicting future currency movements. While some firms may develop sophisticated models incorporating economic indicators, market sentiment, and geopolitical factors, inherent uncertainties make precise forecasts difficult. Therefore, U.S. firms often have limited predictive accuracy in these markets and must hedge their currency risk accordingly.

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