FINM7406 Semester 1 2023 UQ Business School, University of Queensland Assignment Overview This is an individual assignment total of 30 marks counting towards 30% of your final grade. Assignment due: 11 May 2022 13:00. Submit electronically on Blackboard. Covered Interest Rate Parity (30 marks) You are required to investigate whether you can capture an arbitrage opportunity that arises from the violation in Covered Interest Rate Parity (CIP) in USDEUR currency markets. To do so, you need to detect whether such violation in the USDEUR markets ever happened using historical data (interest rates, forward rates, spot rates) from January 2001 to December 2021. Download the data “usdeur2021.csv” from the Assignment Folder1 and complete the following tasks. A. Using daily mid rates, calculate the daily deviations from the CIP. Report the mean and standard deviation of the deviations for each of the two subperiods: January 2001 – December 2007 and January 2008-December 2021. Plot the deviations over time for the entire sample. (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 you first start the position by borrowing 10,000,000 units of a currency ($ or EUR). (5 marks) C. Provide a report to 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, LIBOR offered rates can be used. Submission Info: 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 in a pdf or word 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. Submission: • Submit answer directly onto Blackboard for a. Part A • Please submit one Excel file. Please name the files FINM7406__Lastname_Studentnumber.xlsx where Lastname is your last name, Studentnumber is your student number. You may submit the Excel file as many as you like, but only your last submission will be graded. • Please submit one written report containing answers for a. Part B (approx. 500 words). Your answer should contains the explanation of the calculations. b. Part C (approx. 1000 words). Your answer should demonstrate literature review on covered interest rate parity. It should also demonstrate your understanding and critical evaluation of the literature. The references in Topic 3 Parity lecture folder are very helpful here. c. Only submit the written report once on Turnitin.