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)