of the yen over the next several years. Based on this

information, do you think Raven Co$.$ should hedge

its remittance of expected Japanese yen profits to

the U$.$S$.$ parent by selling yen forward contracts?

Why would this strategy be advantageous? Under

what conditions would this strategy backfire?

Advanced Questions

Probability Distribution of Forecasts. Assume that

the following regression model was applied to his$-$

torical quarterly data:

$)t$

where $e_t=$ percentage change in the exchange rate

of the Japanese yen in period $t$

$)t$ average real interest rate differential

$($U$.$S$.$ interest rate minus Japanese

interest rate$)$ over period $t$

$IN{F}_{t-1}=$ inflation differential $($U$.$S$.$ inflation rate

minus Japanese inflation rate$)$

in the previous period

$a_0,a_1,a_2=$ regression coefficients

${}_t=$ error term

Assume that the regression coefficients were esti$-$

mated as follows:

$a_0=\mathrm{.}0$

$a_1=\mathrm{.}9$

$a_2=\mathrm{.}8$

Also assume that the inflation differential in the

most recent period was $3$ percent. The real inter$-$

est rate differential in the upcoming period is fore$-$

casted as follows:

If Stillwater, Inc., uses this information to fore$-$

cast the Japanese yen's exchange rate, what will be

the probability distribution of the yen's percentage

change over the upcoming period?

Testing for a Forecast Bias. You must determine

whether there is a forecast bias in the forward rate.

You apply regression analysis to test the relationship

between the actual spot rate and the forward rate

forecast $(F)$ :

$S=a_0+a_1(F)$

The regression results are as follows:

Based on these results, is there a bias in the

forecast? Verify your conclusion. If there is a

bias, explain whether it is an overestimate or an

underestimate.

Effect of September $11$ on Forward Rate

Forecasts. The September $11,2001,$ terrorist

attack on the United States was quickly followed

by lower interest rates in the United States. How

would this affect a fundamental forecast of foreign

currencies? How would this affect the forward rate

forecast of foreign currencies?

Interpreting Forecast Bias Information. The trea$-$

surer of Glencoe, Inc., detected a forecast bias when

using the $30-$day forward rate of the euro to forecast

future spot rates of the euro over various periods.

He believes he can use this information to deter$-$

mine whether imports ordered every week should be

hedged $($payment is made $30$ days after each order$).$

Glencoe's president says that in the long run the for$-$

ward rate is unbiased and that the treasurer should

not waste time trying to "beat the forward rate" but

should just hedge all orders. Who is correct?

Forecasting Latin American Currencies. The value

of each Latin American currency relative to the

dollar is dictated by supply and demand conditions

between that currency and the dollar. The values of

Latin American currencies have generally declined

substantially against the dollar over time. Most of

these countries have high inflation rates and high

interest rates. The data on inflation rates, economic

growth, and other economic indicators are subject

to error, as limited resources are used to compile

the data.

a$.$ If the forward rate is used as a market$-$based fore$-$

cast, will this rate result in a forecast of apprecia$-$

tion, depreciation, or no change in any particular

Latin American currency? Explain.

b$.$ If technical forecasting is used, will this result

in a forecast of appreciation, depreciation, or no

change in the value of a specific Latin American

currency? Explain.

c$.$ Do you think that U$.$S$.$ firms can accurately fore$-$

cast the future values of Latin American currencies?

Explain.