Making Informed Decisions: Forecasting FX. Forecasting foreign-exchange rates is notoriously difficult, especially in the short-run. Propose a simple methodology based on prices and costs and assess how well BMW Group has been doing in this regard.

(a) Define and give an example of absolute and relative purchasing power parity in the context of BMWs North-American operations, respectively. How can BMW use PPP to improve on its FX forecasting?

(b) Are implied forward rates good predictors of future spot rates? Investigate their predictive power or absence thereof in the context of BMWs forecasts by computing implied forward rates, comparing them to the Groups forecast, and assessing their quality as a predictor for future spot rates. All the necessary data are provided in the case exhibits.

(c) Given the data provided in the case, what do you think about BMWs forecasts and their reliance on PPP?

(d) In light of BMWs FX forecast, what seems the Finance division expect with regards to the USD in 2007? How will the forecast FX change affect BMW Groups financial position?

(e) Bonus problem. How does the Law of One Price provide information on BMWs competitive position? Taking USD-based car makers as a reference, construct a numerical example to assess EUR-based BMWs competitive position given current FX rates.