MNC corporation must forecast sales, expenses, and cash flows for its operations in different countries. The results from these transactions generated in the home country will depend on the exchange rate between the foreign and domestic currency. Often a company makes substantial investments in foreign operating facilities from which it expects to obtain cash flows. Thus, multinational corporations (MNCs) are vitally interested in forecasting exchange rates in both the short and long run. A frequently used method to forecast exchange rates for relatively short periods into the future is through the forward rate. To understand this, two types of exchange rates must be defined: 1. Spot exchange ratethe price of one currency against another for transactions being completed immediately 2. Forward exchange ratethe price of one currency against another for a transaction that will occur at some point in the future An extremely active exchange market exists, and financial officers can easily ascertain both spot and forward rates for the ten major currencies, which represent a predominant portion of all transactions. One view of the forward rate is that it represents the market's consensus on what the future spot rate should be. Thus, if today's spot rate is $1.998 for 1 British pound sterling and the 90-day forward rate is $1.989, then one can argue that the market consensus is that the pound will decrease in value by $0.009 relative to the U.S. dollar 90 days henc

s the forward rate a good predictor of the spot exchange rate for major currencies? On the average, the forward rate will be equal to the future spot rate; in other words, negative and positive errors in the forecasts will be offset. Therefore, it can be said that the forward rate is an unbiased forecaster of the spot rate. It makes for a bestguess forecast. However, this does not make it an accurate forecast at any one time. Still, for the short run, it is probably as good an estimator as we have. In addition to its lack of accuracy, other shortcomings must be considered: 1. The present exchange rate system does not permit currencies to float freely. Governments interfere in the exchange rate markets when they consider it to be of benefit to their country's economy. 2. Although forward rates can be established for relatively long periods into the future (in some cases, they can go out as far as 10 years), by far the largest volume of forward contracts is for 180 days or less. 3. Reliable forward markets exist only for currencies of the leading industrial economies of the world. Longer-term exchange rate forecasts often use econometric models. A major problem in constructing these multiple regression models is in finding appropriate reliable independent variables. In most cases, the independent variables are stated in terms of differentials between the domestic and foreign measures, such as: 1. Growth rates of GDP 2. Real interest rates 3. Nominal interest rates 4. Inflation rates 5. Balance of payments A significant number of complex models is in use today. Here we use a simple hypothetical model to illustrate the estimate of a relationship between the domestic currency and a foreign currency

Et = a + bIt + cRt + dGt

-where E = Exchange rate of a foreign currency in terms of the domestic currency-I = Domestic inflation rate minus foreign inflation rate-R = Domestic nominal interest rate minus foreign nominal interest rate-G = Domestic growth rate of GDP minus the growth rate of foreign GDP-t = Time perioda, b, c, d Regression coefficients

Such forecasts have all the advantages and disadvantages usually found in the application of regression analysis to economic problems:

1. Which variables should be included? 2. What form should the regression equation adopt? 3. Are accurate measurements of independent variables available? Data may be inadequate for other than the major industrial countries. 4. To forecast exchange rates, it may be necessary to forecast the independent variables. It is not surprising that it may be as difficult to forecast independent variables accurately as it is to forecast the exchange rates themselves.