CHAPTER 9 WHALER PUBLISHING COMPANY

Forecasting Exchange Rates

Whaler Publishing Company specializes in producing textbooks in the United States and marketing these books in foreign universities where the English language is used. Its sales are invoiced in the currency of the country where the textbooks are sold. The expected revenues from textbooks sold to university bookstores are shown in Exhibit B.1.

Whaler is comfortable with the estimated foreign currency revenues in each country. However, it is uncertain about the U.S. dollar revenues to be received from each country. At this time (which is the beginning of year 16), Whaler is using todays spot rate as its best guess of the exchange rate at which the revenues from each country will be con- verted into U.S. dollars at the end of this year (which implies a zero percentage change in the value of each currency). Yet it recognizes the potential error associated with this type of forecast. Therefore, it desires to incorporate the risk surrounding each currency forecast by creating confidence intervals for each currency. First, it must derive the annual percentage change in the exchange rate over each of the last 15 years for each currency to derive a standard deviation in the percentage change of each foreign cur- rency. By assuming that the percentage changes in exchange rates are normally distrib- uted, it plans to develop two ranges of forecasts for the annual percentage change in each currency: (1) one standard deviation in each direction from its best guess to develop a 68 percent confidence interval, and (2) two standard deviations in each direction from its best guess to develop a 95 percent confidence interval. These confidence intervals can then be applied to todays spot rates to develop confidence intervals for the future spot rate 1 year from today.

Exhibit B.1 Expected Revenues from Textbooks Sold to University Bookstores TODAY'S SPOT EXCHANGE RATE EXPECTED REVENUES FROM BOOKSTORES THIS YEAR UNIVERSITY BOOKSTORES IN Australia Canada New Zealand LOCAL CURRENCY Australian dollars (AS) Canadian dollars (CS New Zealand dollars (NZS) Pounds (f) $ .7671 8625 .5985 A$38,000,000 C$35,000,000 NZS33,000,000 United Kingdom 1.9382 34,000,000