Transcript
Currencies & exchange rate mechanics
Presentation includes:•Factors affecting Currency Exchange Rate •Economical Formulas and •Prediction Models
Presented byVivek Kumar Singh
Vanshja GoiralaAjay Singh
Introduction – Is there a fair exchange rate P*?
• For equities, it is the net discounted cash flow of future earnings
• For bonds, it is the net discounted cash flow of future interest payments + principal
• For currencies? There is no universally agreed model of fair value!
Factors affecting exchange rates
Forecasting methodology (for short horizon)
Prediction Models (for long horizon)
• Random Walk model (RW)• Purchasing Power Parity model (PPP)• Uncovered Interest Rate Parity model (UIP)• Sticky Price Monetary model (SP)• Econometric Model• Dornbusch-Frankel monetary model• Hybrid model of monetary factors and productivity
differentials (HBS model)• Taylor Rule Models• Artificial Neural Network based Prediction models• Feed Forward Neural Network (FFNN)• Standard Backpropagation (SBP)• Scaled Conjugate Gradient (SCG)• Backpropagation with Bayesian Regularization (BPR)
U.S Dollar and Swiss FrancUSDCHF
History
Current Exchange Rate
•1 U.S. dollar / Swiss franc = 0.940949757
How inflation affects the fair value P* of USDCHF
CHF finding fair value P* through PPP
Recent Debacle
The Swiss market recorded its biggest daily percentage rise for 25 years on 15/1/2015.
The euro fell about 14.5% against the franc, falling as much as 30%.
Cause* SNB promising a
rate of minus 0.25% and unpegging against USD
Unprecedented Volatility & Aftermath
FXCM Faces Losses on Franc Trades as Swiss Shock Spreads
The value of country's currency reserves went
down by 60 billion francs
FXCM Inc shares dip back below $2 as investors begin to lose faith
Euro and U.S DollarEURUSD
Introduction
How inflation affects the fair value P* of EURUSD
200D EMA (on jul-14) = 1.3643
Date CPI USD CPI EUR Iusd Ieur 1+(Iusd - Ieur) Forecast Actual Forecast error
Jul-14 237.34 118.31 1.3643
Aug-14 237.59 117.54 0.001053 -0.00651 1.00756167 1.3746 1.3422 0.0324
Sep-14 237.4 117.68 -0.0008 0.001191 0.99800922 1.3395 1.3117 0.0278
Oct-14 237.62 118.19 0.000927 0.004334 0.99659292 1.3072 1.2658 0.0414
Nov-14 237.75 118.12 0.000547 -0.00059 1.00113936 1.2672 1.2484 0.0188
Dec-14 237.06 117.91 -0.0029 -0.00178 0.99887564 1.2470 1.2466 0.0004
Jan-15 236.28 117.87 -0.00329 -0.00034 0.99704894 1.2429 1.2096 0.0333
Feb-15 234.67 116.03 -0.00681 -0.01561 1.00879647 1.2202 1.1311 0.0891
Mar-15 235.18 116.78 0.002173 0.006464 0.99570942 1.1262 1.1201 0.0061
Apr-15 235.74 118.11 0.002381 0.011389 0.99099222 1.1100 1.1078 0.0022
May-15 235.98 118.4 0.001018 0.002455 0.99856273 1.1062 1.121 -0.0148
Jun-15 237.03 118.66 0.00445 0.002196 1.00225358 1.1235 1.0952 0.0283
Valuation of EURUSD using PPP model
Data source : tradingeconomics.com
Valuation of EURUSD using PPP model (cont..)
Jul/14 Aug/14 Sep/14 Oct/14 Nov/14 Dec/14 Jan/15 Feb/15 Mar/15 Apr/15 May/15 Jun/151
1.05
1.1
1.15
1.2
1.25
1.3
1.35
1.4
EURUSD - PPP Forecast vs Actual rate
Forecast Actual
Greece crisis breaks down euro?
Could Greece crisis break WTI crude too?
Currency-Crude correlations
•You go long crude, you are effectively short the U.S. dollar.
•The U.S. dollar and crude oil have for many years been inversely correlated.
Disclaimer: Correlation is not causation
Inference
•Prediction of a currency is mainly based on major factors listed in this presentation.
•We have listed popular prediction models in this presentation.
•Currency valuation using PPP, IRP and other formulas are proven by economists and used widely for currency valuation.
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