Assessment :
Data for this assessment has been placed on Canvas.
The data relates to the interest rates and exchange rates of a number of countries. Interest rates are the equivalent annual interest rates on three month treasury bonds, presented on a daily basis. Exchange rates are the daily closing exchange rates between the two countries as they applied on the same day as the interest rates. Forward exchange rates are for three months from day they are presented. The assignment questions are on the theory and actual experience of Uncovered / Covered Interest Rate Parity (CIRP).
ACTIONS
1) Select two countries' data to analyse
2) Starting on your birthday (my birthday: January 15) in 2016, select enough data to analyse CIRP for six months.
You must explain carefully any calculations that you make as most marks are available for demonstrating your method.
QUESTIONS
1) For each day in your sample chart and discuss the relevance to CIRP the following:
a. The equivalent compound three-month interest rate for each country.
b. The difference between the interest rates
c. The percentage change in the exchange rate over the following three months.
2) Three months from your birthday was the exchange rate higher or lower than you would have expected, given the interest rates in the two countries on your birthday? Carefully explain your answer.
3) Choose one of your countries. Imagine you had invested 1000 units of your home currency in the other country and sought to hedge the exchange rate risk.
a. Would you have gained or lost on a zero transactions cost forward contract agreed on your birthday?
b. Show the size of your gain or loss and explain the use of forward contracts in hedging foreign exchange risk.
4) Taking the six months of interest rate data and associated data on exchange rates.
a. Did, on average, Uncovered Interest Rate Parity (UIRP) hold over this period?
b. Explain why you think that UIRP did / did not hold.
c. Based on your findings, explain whether you would conclude that arbitrage is possible in foreign exchange markets.