FINC 5510 Currency Forecast Project

FINC 5510 Currency Forecast Project

You will be assigned a currency for this project. 1. 20 points – Obtain some background on your currency.

1. What is the currency regime for your currency? (IMF can be of some help on this as well as the Bank of International Settlements – which has links to the central banks (central bank hub) for virtually every country). Things to consider:
2. Does the country have an inflation target – if so what is it? ii. What is the current level of unemployment? Document your source and provide a copy since

websites do change. iii. Considering the current economic climate for your country (unemployment), what does this

suggest about whether the country would benefit from a weak or strong currency? b. Obtain a graph of your currency over the past two to five years. (There are several sources – most of

the time you can use their custom features to create your graph – just be sure to give them credit for the chart.) PLEASE NOTE – make sure you know how the currency is quoted. Be aware that higher levels of currency per dollar means the currency has fallen not risen.  FINC 5510 Currency Forecast Project

1. What does this graph suggest about recent trends in the currency and potentially future

direction? 2. 50 points – PPP is the most widely accepted of all exchange rate determination theories. Explore the

expectations of PPP and its expected impact on the expected future spot rate for your currency.

1. (10 points) Go to The Economist (www.economist.com) and using their “Interactive currency-

comparison tool” for the Big Mac index (The Big Mac Index is an example of Absolute Purchasing Power Parity or Law of One Price):

1. Using the RAW INDEX, obtain the implied PPP exchange rate and the percentage your

assigned currency is over/undervalued.

1. Show how this implied exchange rate was calculated using the price of the Big Mac. 2. Show how the percentage over/undervalued was calculated using the actual

exchange rate per the interactive tool and the implied rate (or alternatively using the differences in the dollar cost of the Big Mac). ii. Using the ADJUSTED INDEX, obtain the percentage your assigned currency is

over/undervalued relative to the dollar. iii. Summarize what the most recent Big Mac Index suggests for your currency. b. (10 points ) What should the spot rate be one year from now based on these rates and Relative 

Purchasing Power Parity? 

1. Obtain inflation forecasts for your currency (you will be given the information for the USD). ii. Obtain and document your source for the spot rate for the currency. iii. Make the calculation of the expected spot rate using the PPP formula. c. (10 points) What does the most recent Nominal and Real Effective Exchange Rate suggest about your

currency?

1. Go to www.bis.org to locate effective exchange rate indexes. What are the most

recent nominal and real effective exchange rate indexes for your currency? 2. Summarize what these indexes suggest about your currency. Here is some help.

1. The Nominal effective exchange rate captures the change in the nominal

rate since 2010 (their base period). This is simply the percentage change in the currency value relative to a base currency (in this case a basket of currency). It tells you nothing about changes in purchasing power because it does not incorporate changes in the domestic price levels (inflation). Remember, the nominal exchange rate index tells you nothing about whether the currency is overvalued or undervalued. b. As stated in your text, “if purchasing power parity holds – all the real effective exchange rate indices would stay at 100. If the real effective exchange rate index is above 100, the currency would be considered “overvalued” from a competitive perspective (relative to its 2010 level of

course). An index value below 100 would suggest an “undervalued” currency.” c. In the long run the real effective exchange rate index should tend to 100 as

competitive pressures force the currency back on the equilibrium path, but it can deviate widely in the short-run. d. (20 points) Summarize your findings using the 3 inputs (Absolute PPP, Relative PPP, and Real

Effective Exchange rate index) – and draw a conclusion regarding the future direction based on the PPP information you feel is most relevant. FINC 5510 Currency Forecast Project

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