Covered Interest Rate Parity (CIP) Report Writing - Finance Assignment Help

Assignment Task

Task

Part I: Covered Interest Rate Parity.

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 (interes rates, forward rates, spot rates) from January 2001 to December 2018.

A. Using daily mid rates, calculate the daily deviation from the CIP. Plot the deviation over time.

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. How much profit would you have made? Assume you first start the position by borrowing 10,000,000 units of a currency ($ or EUR). 

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.

Part II: Forward Rate’s unbiasedness.

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.

A. Test the unbiasedness hypothesis using regression analysis and sample averages. Is the forward rate an unbiased predictor of the future spot rate? Your conclusion should be supported by the empirical tests. 

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. 

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