Foreign Exchange Forecasting - Research Paper Example

1. Quantitative Exchange Rate Forecast The RBA exchange rate for September was A US 0703. The forecast for December 31, can be doneby using Exponential smoothing. From the RBA exchange rate data, the actual exchange rates for every 4th month can be extracted as shown in Table 1.1. The data has been taken from January 2004 to September 2011 which is a reasonably long time period for forecasting. Any arbitrary value of smoothing constant (alpha) is chosen. Here 0.4 has been chosen as the value as shown in Appendix.

The smooth values for all periods till January 2012 are calculated using actual exchange rates and forecasted exchange rates of previous time period. The squares of the errors are calculated and their sum is found out. This sum is minimized using solver to come up with an optimum value of alpha as 0.79. The smooth or forecasted exchange rate of January 2012 is taken equivalent to the exchange rate on 31 December, 2011. This value comes out as 1.0665. Table 1.1: Forecasting exchange rates using exponential smoothing   Alpha / Smoothing Constant 0.

790359404     Month Actual Exchange Rate Forecasted Exchange Rate / Smooth Value Error square Jan-2004 0.7644 0.7644 0.0000 May-2004 0.7143 0.7644 0.0025 Sep-2004 0.7147 0.72480299 0.0001 Jan-2005 0.7744 0.716818 0.0033 May-2005 0.7557 0.76232847 0.0000 Sep-2005 0.7615 0.7570896 0.0000 Jan-2006 0.7510 0.7605754 0.0001 May-2006 0.7636 0.75300739 0.0001 Sep-2006 0.7480 0.76137936 0.0002 Jan-2007 0.7720 0.75080486 0.0004 May-2007 0.8244 0.76755664 0.0032 Sep-2007 0.8827 0.81248332 0.0049 Jan-2008 0.8884 0.86797973 0.

0004 May-2008 0.9559 0.88411908 0.0052 Sep-2008 0.7996 0.94085181 0.0200 Jan-2008 0.8884 0.82921211 0.0035 May-2008 0.9559 0.87599182 0.0064 Sep-2008 0.7996 0.939148 0.0195 Jan-2009 0.6438 0.82885493 0.0342 May-2009 0.7912 0.68259502 0.0118 Sep-2009 0.8801 0.76843199 0.0125 Jan-2010 0.8909 0.85668985 0.0012 May-2010 0.8490 0.88372816 0.0012 Sep-2010 0.9667 0.85628043 0.0122 Jan-2011 0.9924 0.94355158 0.0024 May-2011 1.0709 0.98215939 0.0079 Sep-2011 1.0703 1.05229637 0.0003 Jan-2012  - 1.06652571  - Sum  0.1535 2. Factors that could impact exchange rate forecast Inflation and interest rates are the biggest factors which can have an impact on exchange rates.

The inflation in Australia in second quarter was 3.6% which is quite moderate and hence unlikely to impact the forecast. The interest rates also remain unchanged at 4.75% as per recent RBA announcement. Therefore, the current trend in exchange rates is likely to continue. The other factors that could impact exchange rates are current account deficits, public debt, terms of trade and political stability. Australia’s terms of trade are at very high levels but credit growth and employed have declined to some extent.

The inflation is expected to reduce by the year-end. Overall, the Australian economy seems to be doing reasonably well on most counts. However, it is bound to be impacted by the weakened global economy. Therefore, the relative performance of Australian economy with respect to global economy will govern the exchange rates. Hence, the forecasted exchange rate for December 31, 2011 seems fair with a possibility of deviation on the upper side. Appendix Excel Solver Report for optimizing Alpha Target Cell (Min) Cell Name Original Value Final Value $D$33 Error square 0.1733 0.1535 Adjustable Cells Cell Name Original Value Final Value $C$2 Alpha / Smoothing Constant 0.4 0.790359404 Constraints Cell Name Cell Value Formula Status Slack $C$2 Alpha / Smoothing Constant 0.

790359404 $C$2=0 Not Binding 0.790359404 References Monthly Data. Exchange Rate Data. Reserve Bank of Australia. Retrieved September 18, 2011 from Bergen, Jason Van. (2010). 6 factors that influence exchange rates. Retrieved September 19, 2011 from Interest rates updates. Retrieved September 19, 2011 from