Question: (a) Explain three methods of forecasting exchange rates. [6 marks] (b) The forecasting equation for the exchange rate between Kenya shilling and the US dollar

(a) Explain three methods of forecasting exchange rates. [6 marks] (b) The forecasting equation for the exchange rate between Kenya shilling and the US dollar is given by: Yt=a+bXt where Yt is the direct quote for period Xt is the inflation rates differential between Kenya and the US. Historical data has been collected as follows Required: (i) Using Least Square method develop a forecasting model for the exchange rate. [12 marks] (ii) Determine the exchange rate between Ksh. and the USD if inflation rate is expected to be 25% in Kenya and 7% in the US. [3 marks] (iii) Compute the coefficient of determination of the function established in (i) above and explain its meaning. [4 marks] Page 2 of 3

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