Forward Exchange Rates Research Articles

The Hedging Channel of Exchange Rate Determination

Abstract We propose the currency hedging channel that connects countries’ external imbalances to their exchange rate behavior. We present a model in which investors increase their currency hedging during periods of financial distress in proportion to their net foreign asset exposure. This behavior coupled with constrained financial intermediation explains observed relationships between gradually adjusting external imbalances and volatile spot and forward exchange rates. We find empirical support for the hedging channel in both the conditional and unconditional moments of exchange rates, option prices, and countries’ uses of Federal Reserve swap lines. (JEL E44, F31, F32, F41, G11, G15)

Foreign Exchange Risk Analysis and The Futures Hedging Strategy Construction--- The Case Study of Amazon

This paper explores the foreign exchange risk encountered by Amazon.com Inc. and proposes corresponding futures hedging strategies. With global market uncertainties, foreign exchange risk significantly impacts the financial performance of multinational companies like Amazon. The paper analyzes Amazon's foreign exchange risk factors, highlighting that the primary risks stem from international business revenues and holdings of foreign currency cash equivalents and marketable securities. Based on these risk factors, the study proposes several potential hedging strategies, including forward market hedging, futures hedging, and exchange rate options hedging. Forward market hedging mitigates risk by agreeing to exchange currencies at a predetermined rate in the future; futures hedging avoids counterparty default risk through standardized contracts; and exchange rate options hedging offers flexibility by allowing the exercise to be abandoned if the exchange rate moves favorably. The paper further develops a specific futures hedging strategy based on several key assumptions, including efficient market hypothesis, zero transaction costs, unlimited liquidity, and the absence of risk-free arbitrage opportunities. The strategy involves shorting futures contracts; if the exchange rate declines at maturity, the hedge is successful and profitable; if the exchange rate rises, the hedge is unsuccessful, resulting in a loss. The findings suggest that using futures contracts for hedging enables Amazon to stabilize its financial performance in case of market uncertainties, protecting it from adverse impacts of foreign exchange risk. Despite discrepancies between actual sales data and forecasts, the hedging strategy still demonstrates its effectiveness in maintaining financial stability.

Comparative Analysis of Deliverable and Non-Deliverable Contracts in the Hong Kong Trading Market - Taking RMB as an Example

NDFs are over-the-counter traded foreign exchange derivative products. The settlement of an NDF contract does not involve the delivery of the underlying currency pair. Instead, it involves a net payment in a convertible currency (usually the US dollar), which is proportional to the difference between the agreed forward exchange rate and the subsequently realized spot fixing. Hong Kong's geopolitical location as an outlet that connects mainland China to the world gives it an essential role in researching CNY's international features Hong Kong's trading market serves as a crucial link for the expansion of RMB usage, with the resulting shifts in positions supporting the interpretation of the role of RMB in the process of globalization of the currency, as well as the interpretation of financial markets. This study examines how the Hong Kong market serves as a critical hub for the currency's global integration through its trading of RMB, and focuses on the interplay between market regulations, economic policies, and the intricate balance of supply and demand affecting deliverable (CNY and CNH) and non-deliverable forward (NDF) contracts. The research findings reveal that the examination of transaction data from Hong Kong's commodity exchange demonstrates a complicated interconnection between deliverable (CNY and CNH) and non-deliverable forward (NDF) contracts. This intricate relationship highlights the Chinese Yuan's (RMB) fluctuating role in the market, influenced by factors such as market sentiment, regulatory changes, and economic conditions. In essence, the RMB's trading volumes and value in this setting reflect its sensitivity to both domestic and international market shifts.

The price discovery in the renminbi/USD market: Two spot, two swap, and three forward FX rates

This paper employs the vector error correction model (VECM) to measure the contribution of the onshore renminbi spot foreign exchange (CNY) rate to the price discovery of the offshore one (CNH). The VECM incorporates the covered interest rate parity condition by introducing the forward swap rate. Each rate has onshore and offshore markets, and the VECM encompasses the seven variables. This rich VECM challenges the small VECM with only two CNH and CNY rates, revealing an overstatement of the CNH's contribution. Additionally, CNY and CNH are the main contributors to the price discovery of the forward exchange rates. When the central parity is set to be weaker than the previous day's closing of the CNY, the CNY is dominant over the CNH in terms of the information share in the spot FX rate. This effect is amplified after the month of sluggish Chinese exports.

Exchange rates and fundamentals: Forecasting with long maturity forward rates

We show that in a popular model of exchange rate determination, the unobserved expected future exchange rate can be substituted with the observed forward exchange rate. This allows the derivation of a new error-correction forecasting model, which approximates the gap between the fundamental equilibrium exchange rate and the actual exchange rate with the long-maturity forward exchange rate. Our out-of-sample forecasting results for major currencies are unprecedented. The forecasting model is simple, easy to replicate, and the data we use are available in real time and not subject to revisions.

Fundamental Risk Factors and Profitability of Commercial Banks in Kenya

Commercial banks are vital to the financial sector in any country more so in developing economies where capital markets are not well developed and strong. Commercial Banks’ profitability is important because the soundness of an industry is closely connected to soundness of the whole economy. Profitability of the banking sector is also central as the well-being of the industry is closely associated with the wellness of the whole economy in general. Thus, a proficient and productive banking sector is able and better placed to endure negative economic shocks. This study investigated the fundamental risk factors and profitability of Kenyan commercial banks. The study systematically reviewed past studies undertaken on the area of interest. Attention was given on the study findings and the methodology. Conclusions on the relationship that exist between the variables were drawn for the study from the findings of the past studies. Recommendations were made based on the study findings and conclusions. price level fluctuation had a significant positive effect on profitability of commercial banks in Kenya based on return on assets and net interest margin while an insignificant positive effect on return on equity. Exchange rate fluctuation had a significant negative effect on profitability of commercial banks in Kenya based on return on assets and an insignificant negative effect based on return on equity and net interest margin. Interest rate fluctuation on profitability of commercial banks in Kenya. The study found that interest rate fluctuation had a significant positive effect on profitability (return on assets, return on equity and net interest margin) of commercial banks in Kenya. The study recommends that the managers of commercial banks in Kenya should always be in the know of the prevailing economic conditions of the country and that of other countries which they have operational branches. The study found that exchange rate fluctuation is a major predictor of profitability of commercial banks in Kenya (based on return on assets). As such, the managers of commercial banks can engage in foreign exchange hedging practices where the fixed forward exchange rates can be used. The effect of interest rate fluctuation on profitability of commercial banks in Kenya was found to be significant for all the three measures. The study therefore recommends that in periods of high demand for loans, bank managers can take advantage of such periods by charging higher interest rates on loans, however moderately.

Are Determinants of Government Expenditure Symmetry or Asymmetry? Fresh Evidence from Nigeria

Nigeria government has been playing the role of internalizing economic externalities, dealing with issue of unemployment and overall welfare of the populace. However, in the presence of huge and rising government expenditure, unemployment, and inflation rate still persist. This therefore called for a revisit of what determines government expenditure. There are three issues yet unresolved in the debate of what drives government expenditure. These are omitted variables bias, aggregation bias and asymmetry issue. To deal with aggregation bias, we focus on the components of government expenditure, that is, capital and recurrent. To address the issue of asymmetry, nonlinear autoregressive distributed lag was employed. Data are obtained for relevant variables spanning 1981–2021. Model of government expenditure developed by Peacock and Wiseman (1961) combined with Devarajan et al (1996) and Giavazzi, et al (2000) models are utilized. The following results are obtained. First, government capital expenditure is countercyclical while recurrent expenditure is procyclical. Second, some drivers of government expenditure, such as exchange rate and oil price, exhibit asymmetry behavior. Asymmetric tax revenue shows potential to drive capital expenditure but significantly and positively influences recurrent expenditure. Asymmetric behavior of oil revenue and exchange rate also engenders capital expenditure. However, asymmetric behavior of degree of openness and inflation rate negatively affects capital expenditure. Asymmetric behavior of tax revenue and oil revenue posted positive effect while exchange rate and degree of openness have negative effect on recurrent expenditure. Period of election is also a strong positive determinant of recurrent expenditure both in the short and long run. Following the nature of cyclicality of the component of government expenditure, the priority of government could be on capital expenditure since it will provide essential public goods required for the economy to flourish. Bearing in mind that oil revenue is volatile, it is imperative for government to rely more on tax revenue than oil revenue. Engaging in forward exchange rate might be appropriate to deal with any possible exchange rate fluctuation.

EXCHANGE RATE FORECASTING: THE FUNDAMENTAL FORECASTING MODEL

This paper is using the fundamental forecasting model, which is a monetarist theory of exchange rate determination, for the current forecasting. This theory is tested empirically by using data, spot and forward rates and a variety of macro-variables from seven different countries with respect the U.S., as our domestic country. A GARCH-M model is used to forecast the volatility of the spot exchange rate. The paper is also using a Vector Auto-regression (VAR) framework to forecast simultaneously spot (s_t) and forward (f_t) exchange rates by utilizing exogenous macro-variables, time trends, and policy instruments. Further, at the end an impulse response function and a Hodrick-Prescott filter are used to present visually the behavior of the spot exchange rate. The countries used in the empirical work are, U.S. with respect the Euro-zone, Mexico, Canada, U.K., Switzerland, Japan, and Australia. The results show that these methods are giving very good forecasting for these seven exchange rates by minimizing the standard error of the regression (SER) and the root mean squared error (RMSE). Of course, uncertainty exists always in the forecasting of any economic variables, due to unanticipated public policies (monetary, fiscal, and trade) and other “innovations” in our financial markets, plus the new philosophies (i.e., liberalism, lack of ethics, perversions, DEI, AI, wars, BRICS, etc.), official measurements, and value system in our markets, societies, and way of living.

Simultaneous Inference on the Korean Won-US Dollar Forward Premium Anomaly

The forward premium anomaly, which refers to the empirical failure of the uncovered interest parity (UIP), has been primarily examined by the forward premium regression of [Fama, E. (1984). Forward and spot exchange rates. Journal of Monetary Economics, 14(3), 319–338. https://doi.org/10.1016/0304-3932(84)90046-1]. Some studies apply the rolling-window regression to capture the time-varying coefficient on the forward premium, with difficulty in statistically testing the deviation of the coefficient from the UIP over time. We follow [Baillie, R., & Kim, K. (2015). Was it risk? Or was it fundamentals? Explaining excess currency returns with kernel smoothed regressions. Journal of Empirical Finance, 34, 99–111] to apply the simultaneous inference procedure to the Korean Won-US Dollar spot and forward exchange rates by estimating the time-varying coefficient from the kernel-smoothed local-linear regression and constructing the uniform confidence band to test the local deviation. We find that, while the UIP is not rejected from the baseline regression, the simultaneous inference shows that the deviation from the UIP is mainly observed during the early 2000s and 2010s. Time-variation of the forward premium coefficient tends to be significantly affected by economic uncertainties such as the interest rate, inflation, and stock return volatilities in Korea and US.

Trade Data Falsification and Informal Capita Movement: A Study of Bangladesh with Major Asian Trade Partners

The imposition of restrictive trade policies and consequent fabrication of foreign trade statistics acts as hindrance for effective policy formulations in the developing countries. This article presents the trade misreporting scenario of Bangladesh in relation to major Asian trade partner countries (China, India and Singapore) between 1973 and 2018 and examines the possibilities of informal capital movements across borders. Using the vector autoregression (VAR) and autoregressive distributed lag (ARDL) models, we first build partner-level exercise, followed by a combined panel, and find that spot and forward exchange rates, custom duties and real interest rate differences between foreign and home largely affect trade misreporting rates. Interestingly, we also find that the values of past import under-invoicing might also lead to export under-invoicing and vice versa, a two-way causal relationship. JEL Codes: F14, F68, C10, C52

Investigation on transition of RMB forward exchange rate pricing mechanism based on error correction model with structural mutation

The offshore RMB market has been showing a momentum of rapid development. However, the impact of this market on the RMB exchange rate has been less studied. This paper constructs an error correction model with structural mutations and focuses on the turning point for RMB Forward Rate, during the time before and after September 2011. The model is constructed considering the micro-institutional differences between domestic and offshore RMB forward exchange rates, the impact of spreads, the impact of spot exchange rates and international financial market shocks such as the VIX index of the US dollar index. We also apply the error correction model with abrupt changes method to select the model which is innovative. According to the results of the model, the domestic RMB foreign exchange derivatives market and the offshore RMB foreign exchange derivatives market jointly played a leading role in price discovery in the determination of both short-term and long-term RMB forward exchange rates, and we also found September 2011 was an important structural change point for the RMB forward curves both domestic and abroad. Before that period, interest rate parity did not play a positive role and the NDF exchange rate occupied the dominant role in price discovery; the domestic RMB forward exchange rate and the overseas NDF exchange rate were both driven by speculative factors.

CURRENCY MARKET AND MECHANISMS OF ITS REGULATION IN THE SYSTEM OF ECONOMIC SECURITY OF THE STATE

The aim of the work is to improve the system of indicators to assess the economic security of the state in the foreign exchange market and ways to develop mechanisms of its regulation. Methodology. The study is based on a statistical evaluation of currency security indicators in the period 2008-2021, which allowed to establish that: first, the ratio of loans in foreign currency to total gross loans is a clear indicator of currency crises, when the value of the indicator increases to 60%, while in the pre-crisis period it is almost two times lower; secondly, the dollarization of the money supply changed in the range of 25%-33%, that is, the range of variation is insignificant, but in the post-crisis period, its level drops below 30%; thirdly, the level of dollarization of GDP, which is almost two times lower than the level of dollarization of the money supply, is characterized by greater variability and tends to increase in the crisis period and tends to decline in the post-crisis recovery period. The results of the work include a systematization of approaches to the interpretation of currency security and the factors that determine it. According to the narrow approach, currency security is reduced to the state of exchange rate, ensuring the stability of the national currency. Foreign exchange security in a broad sense also implies the ability to automatically set the balance of payments, sufficiency of official foreign exchange reserves, ensuring a stable inflow of foreign exchange into the domestic market with a high export potential and investment attractiveness of the country. Statistical evaluation of currency security indicators in the period 2008-2021 allowed to establish the peculiarities of their interrelation with the signs of currency crises. Proposals aimed at strengthening economic security in the foreign exchange market were substantiated. The practical implication is to improve the methodological recommendations for a comprehensive assessment of the level of currency security of the state based on supplementing the current system of six indicators with two additional indicators – the difference between interest rates on deposits in U.S. dollars and in hryvnias, the level of dollarization of the gross domestic product. The advantage of the first is less informational asymmetry compared to the difference between the forward and official hryvnia exchange rates, the advantage of the second is the demonstration of how much of the gross domestic product is served by the money supply in foreign currency. It is advisable to strengthen economic security in the foreign exchange market through the coordinated implementation of monetary, currency, fiscal, structural and investment policies, soft dedollarization, the use of financial derivatives and international lending. Value/originality. The proposed mechanisms of currency market regulation in the system of national economic security are based on the separation of narrow and broad approaches to the interpretation of currency security of the state, as well as on the clarification of conditions for the use of currency liberalization tools in the system of formation of a full-fledged competitive currency market and deregulation of currency control.

Why exchange rate pass-through matters in forward exchange markets

Persistent deviations from a covered interest rate parity (CIRP) have been observed between the United States (US) and the United Kingdom (UK) from January 2002 to August 2020. This study argues that the CIRP does not hold because even if income from domestic and foreign investments is equalized, foreign investment's utility could be higher than that of domestic investment depending on the exchange rate pass-through (ERPT) into import price. Theoretically, the deviations of observed forward exchange rates from CIRP conditions are attributed to changes in importable goods prices and ERPT. A change in net capital flow affects import price volatilities and deviations from the CIRP. Therefore, the forward exchange rate depends not only on the interest rate differential between countries but also on ERPT into the import price. Using a logarithmic utility function, this study derives a utility-equalizing forward rate (UEFR). An increase in net capital outflow and the ERPT into the import price reduces the UEFR. Our empirical evidence shows that from December 2011 to June 2020, the UEFR estimates trace the actual US−UK forward exchange rates better than CIRP.

Return and volatility connectedness of Chinese onshore, offshore, and forward exchange rate

AbstractWe analyze the return and volatility connectedness between the three Chinese exchange rate markets, namely, the onshore market, the offshore market, and the nondeliverable forward offshore market. Our results show that connectedness exhibits an increasing trend with fluctuations during periods of internal reforms and external shocks. For example, the connectedness increased with China's exchange rate reform on August 11, 2015 but dropped after that. Furthermore, we document that the offshore spot and a forward market dominated the other rates in return spillovers. In contrast, both the offshore and onshore forward rates dominated the other rates in volatility spillovers.

Puzzling exchange rate dynamics and delayed portfolio adjustment

The objective of this paper is to show that the proposal by Froot and Thaler (1990) of delayed portfolio adjustment can account for a broad set of puzzles about the relationship between interest rates and exchange rates. The puzzles include: i) the delayed overshooting puzzle; ii) the forward discount puzzle (or Fama puzzle); iii) the predictability reversal puzzle; iv) the Engel puzzle (high interest rate currencies are stronger than implied by UIP); v) the forward guidance exchange rate puzzle; vi) the absence of a forward discount puzzle with long-term bonds. These results are derived analytically in a simple two-country model with portfolio adjustment costs. Quantitatively, this approach can match all targeted moments related to these puzzles.

Pergerakan kurs spot dan kurs forward pada future spot

The purpose of this research are to determine the movement of the spot rate on the future spot, the movement of the forward rate on the future spot, the movement of the spot rate and the forward rate on the future spot. This research uses two quarters, that is quarter I to quarter II of 2019. This research uses regression models for the forecasting method. The variables are the spot rate, forward rate, and future spot. Samples were obtained from BI. The regression model was tested using the classical assumption test. The results of the data analysis show that the spot rate has a significant movement on the future spot, this is evidenced by the regression coefficient value of -2.9938 and a probability value of 0.0042. The forward exchange rate also shows the results of significant movements on the future spot, as evidenced by the regression coefficient value of -2.9581 and a probability value of 0.0046. The spot rate and forward rate together have an effect on the future spot, as evidenced by the results of statistical analysis with an F-Statistical value of 5.5895 and an F-Statistical probability value of 0.0063.

Trade Mis-Invoicing Between India & USA: An Empirical Exercise

India shares its majority of international trade with the United States of America. But a huge amount of discrepancy is frequently observed in the recorded bilateral trade statistics between these two countries. The main reasons are caused by several restrictions prevailing on the account of international trade in India. Export is found to be under-reported consistently whereas import data shows both over and under mis-invoicing in a periodic swing. This paper focuses on the determinants of this data fabrication with the help of empirical exercises. Several macroeconomic policy variables are taken to build up an econometric model and are tested statistically with the help of time series econometrics. Among all, relative interest rate plays the most important role to influence export and import mis-invoicing, followed by spot exchange rate and forward exchange rate. The exercise also finds a uni-directional causal relationship from import mis-invoicing of a period to export mis-invoicing of the next period. JEL Codes: C10, C13, C61, F13, F14, F21, K42

Cross-border DCF valuation: discounting cash flows in foreign currency

The paper seeks to develop a comprehensive framework to cross-border discounted cash flow valuation. Although the literature on company valuation and on international financial management is vast, such a framework has not yet been proposed. We build upon well-known fundamentals and relevant contributions, e.g. on the derivation of the risk-adjusted rate of return. Relevant risks are exchange rate risk, business risk, financial risk, the risk of the tax effects induced by debt financing, and the risk of default. Additional tax effects beyond the well-known tax shield on interest expenses must be considered. Risk discounts from cash flows and risk premia to be added to risk-free interest rates are derived according to the global capital asset pricing model. A conceptual choice occurs not only between the foreign currency and the home currency approach, but also regarding the estimation of future exchange rates. The paper shows how a valuation can be implemented with or without consideration of covariances between cash flows and rate of returns with exchange rates. It also derives the discount rates if forward exchange rates are applied. We discuss the consequences of assuming the uncovered interest parity to hold. We assume deterministic debt and apply the adjusted present value approach. In addition, we derive the RADR to be used in the flow to equity and weighted average cost of capital approach. The paper addresses not only the valuation of a foreign company, but also the valuation of a domestic company that generates cash flows in foreign currency and/or uses debt in foreign currency.

Predicting the Forward Exchange Rate and the Effectiveness of Hedging Accounting

This paper shows how prediction accuracy for forward exchange rate negotiated for a forward contract can be a major reason to help entities avoid the risk of loss and understating or overstating income and financial position. I used a double exponential smoothing model to predict the forward exchange rate for US dollar to Canadian dollar. I find prediction accuracy when running the model to the time series of the exchange rate.

Futures crude oil prices as predictors of spot prices: lessons from the foreign exchange market

Thanks mainly to the work of Post Keynesian economists, it is no longer universally accepted that the forward exchange rate is an accurate, unbiased and efficient forecaster of the spot exchange rate. However, the proposition that futures prices of crude oil can be used to forecast spot prices seems to be accepted without much scrutiny. This proposition is challenged both theoretically and empirically, suggesting instead that futures prices have nothing to do with forecasting. Since spot and futures prices are related contemporaneously, futures prices are as good or as bad forecasters as spot prices, in which case it is not sound to use the futures price as a forecaster and the spot price as a benchmark. The results show that spot and futures prices are not as good forecasters as they are portrayed to be. While futures prices produce small forecasting errors, because they are related contemporaneously to spot prices, they fail to capture turning points and exhibit signs of biasedness and inefficiency. Adjusting the random walk and the unbiased efficiency equations, by including a time-varying risk premium or a drift factor, does not make the models better in terms of predicting turning points.