FINM7406 S1 2022 Assignment
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FINM7406 Semester 1 2022
UQ Business School, University of Queensland
Date: 18th March 2022
Assignment Overview
This is an individual assignment total of 100 marks counting towards 30% of your final grade.
Assignment due: 20th May 2022 14:00. Submit electronically on Blackboard and Turnitin.

Part I: Covered Interest Rate Parity (50 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 2018.
Download the data “usdeur.csv” from the Assignment Folder1 and complete the following tasks.
A. Using daily mid rates, calculate the daily deviation from the CIP. Plot the deviation over time.
(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). (10 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. (30 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.
FINM7406 S1 2022 Assignment
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Part II: Forward Rate’s unbiasedness (50 marks)
This task requires you to decide whether a U.S. international portfolio investor or a U.S multinational
corporation with operations in Europe should hedge or speculate in the currency markets. Forward rate
is thought to be an unbiased predictor of the future spot rate (unbiasedness hypothesis). You are required
to test the unbiasedness hypothesis using regression analysis with quarterly data.
Download the data “usdeur.csv” from the Assignment Folder. Note that the data is at daily frequency,
so to do this exercise, you need to convert the frequency of the data to quarterly i.e. one data point per
quarter for each variable. Complete the following task.
A. Test the unbiasedness hypothesis using regression analysis and sample averages.3 Is the forward
rate an unbiased predictor of the future spot rate? Your conclusion should be supported by the
empirical tests. (20 marks)
B. Provide a report to advise whether the investor or the firm should hedge or speculate on the
currency markets. Your report should reflect your critical understanding of the test results, the
unbiasedness hypothesis, and the implications of its deviation on hedging or speculating
practices. Your discussions/reasonings/arguments should also be supported by empirical
academic and/or industry research. (30 marks)

3 Perform the tests on 1) mid rates 2) log scales i.e. log spot mid rates (returns), log forward mid rates
(premium/discount).
FINM7406 S1 2022 Assignment
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Submission Info:
Notes:
• Excel: Your Excel files 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 or word document is required for Turnitin
check.
Submission:
• Please submit two Excel files, one for each Part on the Blackboard site. Please name the files
FINM7406_PartX_Lastname_Studentnumber.xlsx where X is the problem number, Lastname is
your last name, Studentnumber is your student number.
• You may submit these Excel files as many as you like, but only your last submission will be
graded.
• Please submit one written report containing answers for Parts I.C (approximately 1200 words),
and II.B (approximately 1200 words). Only submit the written report once on Turnitin.