Mohamad MOURAD – Summer Term 2022 UNSW Sydney

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FINS5516 – International Corporate Finance
Summer Term 2022, UNSW Sydney
Course Assignment
DUE: Monday 31st January 2022, 5pm (Sydney time)

Marking Criteria

This assessment is worth 15% of your final grade for FINS5516 – International Corporate
Finance.

Purpose of this Assignment

The whole purpose behind this assignment is to get students to apply and assess the
relevance of the International Parity Conditions and Purchasing Power Parity (PPP) Theory in
a practical setting and using actual data and basic statistics. Students enrolled in this course
should also have a working knowledge of Microsoft Excel – which will be used in this
assignment for general calculation and plotting data into graphs. This assignment is similar to
how economists and analysts in industry approach the topic of exchange rates.

-----IMPORTANT NOTE-----

The departure of the previous tutor during the term has caused some disruption to existing
assessments. To adequately compensate all students for this disruption, the following will be
implemented: students that submit responses to the assignment questions will automatically
receive 2 percentage points of the 15%. In other words, the lowest mark each student will
receive if they submit this assignment is 2/15 (assuming no plagiarism, no lateness of
submission and no academic misconduct).

This assignment is individual work and must be submitted as individual work only.















Mohamad MOURAD – Summer Term 2022 UNSW Sydney

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International Parity Conditions/PPP Theory Assignment Questions

We will focus on the US and Australia. Refer to the attached Excel file which has key
macroeconomic data for both countries.

1. Use the realised rates of inflation for both countries from 2004Q1 to 2021Q1 to
calculate the USD/AUD exchange rate according to relative PPP. In other words,
suppose we are in 2004Q1, and we want to forecast the USD/AUD exchange rate one
year ahead. Repeat for each quarter in the sample period. Refer to Exhibit 4-7 in the
textbook (page 151) to give you a sense of what is being expected. How well does this
international parity condition explain the USD/AUD exchange rate? You will need to
compare the RPPP-implied exchange rate with the realised exchange rate. Plot the
two time series in a graph and report the average disparity between the two. Are there
any periods where there is a large disparity between the realised exchange rate and
the RPPP-implied exchange rate? Provide commentary as to the reasons in
approximately 150 words. (2 marks)

2. Between 2010Q4-2013Q1 the Australian dollar’s value reached parity, and also
exceeded parity against the USD. Using the data provided identify the reason(s) for
the appreciation of the AUD against the USD. You can also refer to other sources to
support your argument. Is such an outcome consistent with what you have learnt thus
far in this course about PPP theory? (2 marks)

3. Can PPP theory explain the reason(s) for the decline in the AUD against the USD
during the global financial crisis (see 2008Q2 to 2009Q1)? Calculate the percentage
change in the USD/AUD exchange rate over this period. What other economic factors
could have been at play? Provide commentary (approximately 150 words). (1 mark)

4. Using the data provided in the Excel file, calculate the value of the real exchange rate
(USD/AUD) at the end of the sample period, and compare it with the value of the real
exchange rate at the start of the sample period. Provide brief commentary about the
reasons for the change or lack thereof in the real exchange rate in approximately 150
words. You should focus on the effect of inflation rates, real interest rates, and which
agents in the two economies benefitted from the changes in the real exchange rate
(for example, were importers or exporters the main beneficiaries?) (3 marks)

5. Consider the following econometric structural model of the USD/AUD exchange rate:

Δ/ = 0 + 1Δ, + 2Δ, + 3 + 4 +

where
Δ/ is the change in the USD/AUD exchange rate over period .
Δ is the annual percentage growth rate in real GDP over period
is the inflation rate differential for period
is the interest rate differential for period


(1)
Mohamad MOURAD – Summer Term 2022 UNSW Sydney

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Table 1 below summarises the regression output of the model presented in Equation 1 using
selected forecast horizons: a 1-quarter horizon, 1-year horizon and a 3-year horizon.
Table 1.
Variable/Particular 1-quarter
horizon
1-year
horizon
3-year
horizon
Intercept
0.005
(0.732)
0.027
(0.421)
0.708
(0.000)
Real GDP Growth Aus
0.802
(0.304)
1.697
(0.307)
-1.260
(0.502)
Real GDP Growth US
-1.041
(0.063)
-2.363
(0.03)
1.162
(0.180)
Inflation Rate Differential
1.079
(0.222)
2.775
(0.114)
-0.940
(0.597)
Interest Rate Differential
-0.818
(0.439)
-2.738
(0.183)
12.151
(0.000)
Adjusted R-squared 4.20% 9.83% 41.22%
F-stat 1.749
(0.150)
2.772
(0.035)
10.991
(0.000)
Number of observations 69 66 58
Note: all numbers appearing in parentheses are p-values.
You will need to refer to Table 1 to answer the questions below. Provide concise responses.
a. Analyse the statistical significance of the coefficient estimates in Table 1 at the 5%
level. (1 mark)
b. Consider both the F-statistic (at the 5% level of significance) and the adjusted R-
squared as the forecast horizon increases from 1 quarter to 3 years. Interpret these
figures for the 3-year horizon output in Table 1. Provide some commentary and briefly
discuss whether such results are consistent with PPP theory. (1 mark)
c. Which macroeconomic variable(s) are considered statistically significant at the 5%
level) and economically important for modelling changes in the USD/AUD exchange
rate? Are you surprised by these results? (1 mark)
d. The latest forecasts of the key macroeconomic variables are:

Macroeconomic Variable Forecast
Real GDP Growth (Australia) 3.20%
Real GDP Growth (US) 3.30%
Expected Inflation Rate (Australia) 3.012%
Expected Inflation Rate (US) 5.288%
Interest Rate (Australia) 1.638%
Interest Rate (US) 1.579%

Use these values to estimate the change in the USD/AUD exchange rate in 1 years’
time. Which currency is expected to appreciate based on your calculation? Is this
consistent with PPP theory? (1 mark)
Additional Important Information to Note:
a. One mark out of the 15 marks will be allocated to grammar, spelling and
professionality of the responses given. You need to ensure that your work is
polished and contains NO errors. Remember you are presenting your work.
When you are working professionally, the market expects high quality output.
Mohamad MOURAD – Summer Term 2022 UNSW Sydney

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b. All responses to this assignment must be in English. Submissions in any other
language will result in a 0 for this assignment.
c. Lengthy responses to questions will result in only the first 150 words of each
part being graded.
d. You must type your answers and submit as a PDF document via Turnitin.
Ensure that the cover sheet is attached with your submission. See Moodle for
cover sheet. A submission without the coversheet will result in 2 marks being
deducted. Also submit your Excel file with the calculations.
e. If you use sources in your answers, ensure that you formally cite them. The
style of referencing is for you to decide.
f. There is NO grace period for any submissions.
g. Late submissions will attract a 2-percentage point penalty per day following the
assignment due date (weekend days included). For example, if your
assignment is submitted late by one day and your grade for the assignment
was 12/15, the 2-percentage point penalty will imply that your adjusted grade
is 10/15. A submission made one week (that is, 7 days) after the specified due
date will result in a grade of 0 for this assignment.
h. Your answers must be written by you and only you. Turnitin has a similarity
indicator and submissions with similarity greater than 10% will incur a loss of
marks commensurate with the degree of similarity above this threshold. For
example, if a submission obtains a similarity of 33%, then 23% of the student’s
assignment grade will be deducted. If the student obtains 12/15, then the
adjusted assignment grade will be 9.24/15. This is calculated as (1-0.23)*12.