question archive FIN3IFM EXCHANGE RATE BEHAVIOR TASK OVERVIEW Lecture week 4 introduces the concept of arbitrage and parity theories – interest rate parity (IRP), purchasing power parity (PPP), and international Fisher effect (IFE)
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FIN3IFM EXCHANGE RATE BEHAVIOR
TASK OVERVIEW
Lecture week 4 introduces the concept of arbitrage and parity theories – interest rate parity (IRP), purchasing power parity (PPP), and international Fisher effect (IFE). Lecture 3 introduces the foreign currency market, its equilibrium condition, factors affecting the exchange rate, why the government controls the exchange rate, and the way government interferes in the foreign exchange market. Building on the concepts primarily related to Week 3 and 4, this Exchange Rate Report aims to test and expand your understanding to assess whether IRP, PPP, and IFE hold in the forex market with regards to AUD/USD pair over the past 5 years.
The task requires you to collect the following data from various open sources.
Helpful Data Sources:
Yahoo Finance
(https://au.finance.yahoo.com/quote/AUDUSD%3DX/history?p=AUDUSD%3DX) Barchart
https://www.barchart.com/futures/quotes/A6*0/historical-prices?viewName=main
Reserve Bank of Australia – for monthly interest rate and inflation rate in Australia.
Federal Reserve Bank for monthly inflation rate
(https://fred.stlouisfed.org/graph/?g=1ED0) & monthly interest rate
(https://fred.stlouisfed.org/series/DGS3MO#0) in the USA.
You can also use other sources that you find more convenient.
You are required to analyse the mean, median, and volatility of each data series. You are required to use graphs for meaningful visualization of your data series.
Present a meaningful economic explanation of the trend of the AUD/USD spot exchange rate. What are the main factors that explain the changes in the value of the Aussie dollar against the USD during the last five years? You are required to use the relevant factors that have been covered during the lectures. These include economic factors – trade and finance related, government intervention, political factors, government policy regulations, etc. You are expected to spend significant time in this section.
Examine the trend of spot exchange rate and future exchange rate. Do you find any links? Identify whether the future exchange rate includes a discount or premium for each quarterly period (total 20 quarters)? Present your result in a table and a graph. Note that while forward rate and future rate are not the same, you can use these terms interchangeably for this assignment for reasons mentioned earlier.
Using the last five years (60 data points), examine whether IRP, PPP, IFE holds. Present your result in tabular and graphical form. What are the implications you can draw from your analysis about potential actions by market participants (MNCs, Banks, forex traders)?
Since you will have quarterly future rate data from public sources, you can use the linear/nonlinear interpolation method in Excel / Numbers or other data analyzing software to fill the missing data to generate monthly future rates. If you are unsure of what is interpolation, and how to do that in Excel, please visit credible websites to form your understanding.
Create a professional cover page. You are training to be a professional. See the cover page of a report by IMF. It is simple but professional. You can click the image and see the full report. I want you to draw inspiration from this or similar reports to prepare your one.
Table of contents presents the main headings and the subheadings of each topic / chapter /section. Both the main headings and subheadings should be hyperlinked to the respective page. It should label the page number for each section as well.
The executive summary should contain key highlights of the report.
This section should highlight the background of this report – why you are preparing this report, what is the main focus, what this report wishes to achieve etc. Please keep it short.
This section should highlight the nature of the data, data frequency – monthly, quarterly, or yearly; what are the variables you collected, very brief definition of each variable, what are the sources, etc.
It should also highlight if you have used an alternative measure to define a variable i.e. future rate for forward rate etc. You should also mention briefly if you have used any techniques i.e. average, interpolation, or extrapolation to convert data in a different frequency than what the original data has been.
It should also report the summary stats table. Provide summary stats of each variable, any correlation among the variables, etc. Any initial inference about the variables and potential implication for the exchange rate.
This is an important section. Students are expected to provide the economic explanation not just in the theoretical sense but in the applied sense to justify the behavior of exchange rate movements in the spot market over the period.
The use of meaningful graphs is key to set the context to expand the economic arguments. You are required to explain the major trends and intermediate trends that you observe in the sport rate movement during the last 5 years.
A significant part of this section requires students to research online from credible sources i.e. Federal Reserve System, Reserve Bank of Australia, reputed news articles to identify policy measures – regulatory, economic, and political – undertaken by the respective governments that explain the behavior of exchange rate movement.
It is important to note that policy taken by other countries can also affect the AUD/USD exchange rate. Such information can also be incorporated in explaining the behavior of the AUD/USD movement.
In this section, students should use the future exchange rate to examine the trend and determine how it diverges from the spot rate.
Identifying any discount or premium for each quarterly/monthly future exchange rate and linking the policy measures – regulatory, economic, and political - are key in explaining whether the premium or discount is justified or not.
The use of charts, graphs, and tables is also important. Testing IRP, PPP, and IFE
The student should outline what is IRP, PPP, and IFE? What how these parity theories are tested. What are the steps taken to test these theories using the last five years (60 data points) data?
Use both tabular and graphical presentations. If you are not sure how to create a four-quadrant scatter plot in excel, you can take help from
YouTube.
The focus should be given to articulate the potential implications that can be drawn from your analysis
about potential actions by market participants (MNCs, Banks, forex traders). For example, whether speculation, covered interest arbitrage, increase in import and export are likely to take place due to lack of IRP, PPP, and IFE if observed in the data.
Please provide a summary of the report. Mention your key findings. Include a brief outline of the limitations of your analysis by highlighting further considerations that should have been incorporated, but were not possible for some justified reasons.
Follow APA style of referencing within the body of the text and in the reference section for all sources of information.
This section should include any appendix tables. graphs that have not been presented in the text or the excel sheet.
While you are encouraged to discuss with other classmates when preparing the report, you must conduct the analyses and write the report independently. By submitting the report mentioned above, you confirm that it is your work. Any suspected plagiarism will be reported to the Academic Integrity Committee. If you are found to copy someone else’s work or collude with someone else, you
might get a zero for your assignment and in some cases may lead to further liabilities.
7. TENTATIVE MARKING SCHEME[2]:
Executive Summary [100 words]- concise, meaningful, and professional |
05 |
Introduction [100 words] – meaningful and covering:
|
05 |
Data and Summary Stats [150 words]:
|
10 |
Exchange Rate Behavior [350 words]
|
30 |
Future Exchange Rate [200 words]
|
20 |
Testing IRP, PPP, and IFE [200 words]
|
25 |
Conclusion [100 words]
|
05 |
TOTAL |
100 |
[1] Note that ideally you would require forward rate not future rate to test interest rate parity. But the data on forward rate is difficult to obtain from a public and free sources. Hence, you will use future rate as an approximation of forward rate to determine the forward premium or discount. Please note this limitation in the appropriate place of your report.
Professional cover page & table of contents is a must. Absence of cover page & table of contents will be marked down by 20%. The approximate word count better align with workload required for weight of the assessment. Overall marks will be converted into 10% for overall assessment of this subject.
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