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3 Common Ways to Forecast Currency Exchange Rates

Making proper use of currency exchange rate forecasts can significantly aid stockbrokers and businesses to come up with accurate decisions. Informed choices are a prerequisite for minimizing risks and thus making maximum returns.

What Is a Forecast Currency Exchange Rate?

Exchange rate forecasts are obtained by working out the value of a given currency in relation to other overseas currencies over a given period of time. Currently, there are several theories that exist to forecast exchange rates. However, each one of them comes with its own drawbacks.

Fundamental approach – This prediction technique uses straightforward data regarding a particular country. For example, GDP, productivity, inflation rates, unemployment rates, and balance of trade. The assumption is that the ‘real worth’ of a given currency will eventually surface at one point in time. This approach is favorable for long-term ventures.

Technical Approach – In this method, the venture capitalist outlook influences the variations in the exchange rate. To make predictions, this approach uses a chart detailing the patterns.

Let’s get to know more about the three well-known methods of exchange rate forecasting.

Purchasing Power Parity

Purchasing power parity (PPP) is one of the most commonly used strategies that’s founded on the ‘Law of One Price’ theory. According to this assumption, all identical items should be worth the same amount of money, irrespective of the country. For example, a coke soda in Thailand should be priced the same as in the United States. However, the final price should be determined after calculating the exchange rates and shipping fees.

PPP also incorporates inflation data from one country to the other country. Let’s assume Thai prices are forecasted to increase by 3% and the United States’ prices to go up by 1%. The inflation variation should be 2%.

Thus, the PPP strategy predicts that the Thailand currency would have to decrease in value by around 2% to balance parity.

1 Thai Baht = $0.03.

(1 + 0.02) * (US$0.03 per 1 THB) = US $0.0309 per 1 THB

Relative Economic Strength Approach

The approach method is less accurate compared to the PPP method. It has more to do with an overall assessment of a particular country’s currency rate. The relative economic strength approach focuses on the economic growth rate in a particular country. If a country is indicating an economic upward trend, it’ll be fairly good to conclude that this trajectory will lure investors.

For an individual or a business to make investments, they must first of all purchase that country’s currency. This will most likely create an increase in demand, thus boosting the currency rate. High-interest rates are also a positive indication for investors, also influencing the currency to increase in value.

Econometric Models

This approach can be complex at times because it is based on an economic concept. Essentially, you select an economic element that can potentially influence currency and then come up with a simulation-based on it. For example, let’s select GDP growth rates plus interest rates as our economic indicators. We can develop a model that may be similar to this:

USD/THB = Z + a(GDP) + b(INT)

The primary idea here is that the GDP & INT variables are affected by the a and b coefficients. These elements impact the exchange rate, either by being negative or positive.

It’s important to note that, before making any payments overseas in euros, pounds, yuan, or any other recognized currency, you should consider getting visibility into live exchange rates. Consider giving the Western Union exchange rate converter a try.

Conclusion

Exchange rate predictions are considerably complex, and because of this, investors and companies decide to just hedge their currency risk. On the other hand, those who spot opportunities in forecasting rates of exchange can utilize these approaches.

 

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