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FINM7406 Assignment
Assignment Overview
This is an individual assignment total of 30 marks counting towards 30% of your final grade.
Assignment due: 9 May 2024 13:00. Submit electronically on Blackboard and Turnitin.
Covered Interest Rate Parity (30 marks)
You are required to investigate whether you can capture an arbitrage opportunity that could arise from
the violation in Covered Interest Rate Parity (CIP) in USD, EUR, and AUD currency markets. To do
so, you need to detect whether such violation in the markets ever happened using daily historical data
(interest rates, forward rates, spot rates) from January 2001 to December 2023.
Download the data “data.xlsx” from the Assignment Folder.1
For each currency pair i.e. USDAUD and USDEUR, complete Task A and Task B:
A. Using daily mid rates, calculate the daily deviations from the CIP. Plot the deviations over time
for the entire sample. Report the mean and standard deviation of the deviations for each of the
two subperiods: January 2001 – December 2007 and January 2008-December 2023. (10 marks)
B. Is there any severe violation of the CIP? If there is, choose the day when the largest deviation
occurred and construct a trading strategy to capture the opportunity. The trading strategy should
be constructed realistically i.e. bid-ask rates should be considered here.2 How much profit
would you have made? Assume that you first start the position by borrowing 10,000,000 units
of a currency (USD, AUD or EUR). (5 marks)
Provide a written report to answer the following Task C:
C. Discuss the potential reasons driving the CIP violation. The report should demonstrate your
critical assessment whether there were in fact profitable arbitrage opportunities from the
violation? Hint: Look at the time-series plot of the deviation and think about when the CIP
violation tends to happen and why that is the case. Your critical discussion should be supported
by evidence from Parts A and B above, as well as academic and/or industry research.
(15 marks)
1 All of the relevant data are downloaded from the Bloomberg. Please read the data description carefully.
2 Spot and forward bid-ask rates should be used instead of mid-rate. For the US and EUR interest rates,
interbank offered rates are used. For AUD, 3-month bank bill swap rates are used.
FINM7406 S1 2024 Assignment
2
Submission Info:
Submission:
• Submit one Excel file on Blackboard containing answers for:
a. Part A and Part B (calculations only)
b. Name the Excel file “FINM7406__Lastname_Studentnumber.xlsx” where Lastname is
your last name, Studentnumber is your student number.
c. You may submit the Excel file as many as you like, but only your last submission will be
graded.
• Submit one written report on Turnitin and Blackboard containing answers for:
a. Part B (approx. 500 words). Your answer should contain the explanation of the
calculations in the Excel file.
b. Part C (approx. 2000 words). Your answer should demonstrate literature review on
covered interest rate parity as well as your interpretation of the answers in Part A and Part
B. It should also demonstrate your understanding and critical evaluation of the literature.
The references in Topic 3 Parity lecture folder are helpful here.
c. Name the PDF file “FINM7406__Lastname_Studentnumber.pdf” where Lastname is
your last name, Studentnumber is your student number.
d. Only submit the written report once on Turnitin.
Notes:
• Excel: Your Excel file should include all workings and calculations. Formulas for the calculations
should have cell references wherever possible. If you have computed a number incorrectly and
just typed that number into the spreadsheet (or typed a formula using numbers when cell
references could have been used), you will not receive partial credit for any portion of your
computation that is correct.
• A written report (maximum 2500 words) in a pdf document is required for Turnitin check.
• References should be in Harvard style. References should come from high quality sources e.g.
academic journals, industry reports, World Bank, IMF, etc