Question
BONUS POINTS ASSIGNMENT TESTING FOR INTEREST RATE PARITY In this assignment you are given the following: 1. Select current exchange rates 2. Select Interest rates
BONUS POINTS ASSIGNMENT
TESTING FOR INTEREST RATE PARITY
In this assignment you are given the following:
1. Select current exchange rates
2. Select Interest rates of a country for one year
3. Select Forward exchange rates for Currency pairs (5 of them)
4. Select Futures exchange rates for Currencies (4 of them)
Assume you are working with 1,000,000 units the country currency. You are going to do currency carry trade and see whether you can make a profit. You are actually testing the Interest Rate Parity Theorem using forward or futures contract.
What you need to do:
1. Borrow in one low interest country 1,000,000 units by paying the low interest rate for one year.
2. Convert it in today's exchange rate to a high interest rate country currency.
3. Invest the money in a high interest rate country and earn the one year high interest rate.
4. Simultaneously, today itself you lock into a Forward Contract or a Futures Contract of the Currency you borrowed so that you can pay back the money at the end of the year.
5. Now do the computations: When you return the money in one year are you making any profit or loss?What is the rate of return as a percentage of your original investment of 1,000,000 units?
6. Make any assumptions necessary and state that.
7. Repeat this for other possibilities and compute the highest return strategy.
Sample Answer:
For example, you can borrow 1,000,000 units of Yen in Japan at 0% interest rate, convert it to USA dollars at today's exchange rate ($1= 110.443) and invest in USA and earn 2.35%.Simultaneously, you can use either the forward rate to lock in the future payment. The USD/JPY forward rate quote is: -334 (bid price). This translates [-334/10,000] to 110.443 - 0.0334 = 110.4096 at which rate you will transfer the currency.
If you use futures contract, you will convert the US Dollars to Japanese Yen at the rate of 0.935450.After paying off the debt are you making any money? If so, what is the rate of return?
There are multiple scenarios and possibilities of using Forward and Futures Contact.
Currency Exchange Cross Rates Today
Symbol
Name
Last
^AUDJPY
Australian Dollar/Japanese Yen
78.883
^AUDUSD
Australian Dollar/U.S. Dollar
0.71422
^GBPAUD
British Pound/Australian Dollar
1.80374
^GBPJPY
British Pound/Japanese Yen
142.303
^GBPUSD
British Pound/U.S. Dollar
1.28845
^USDJPY
U.S. Dollar/Japanese Yen
110.443
^USDZAR
U.S. Dollar/South African Rand
14.09597
Source:https://www.barchart.com/forex/major-rates
FORWARD RATES
What are forward points?
When an investor enters into a forward currency contract they are generally quoted forward points. Forward points are added or subtracted to the spot rate and are determined by prevailing interest rates in the two currencies (remember: currencies always trade in pairs) and the length of the contract. Typically, the higher yielding currency has negative points, while the lower yielding currency has positive points. That is to say that if a currency has a relatively higher yield then it will typically cost less in the forward market, if a currency has a relatively lower yield it will typically cost more in the forward market. If this did not hold true, an arbitrage situation may be presented, which in itself could drive prices to equilibrium.
Forward Computations
Forward points are commonly quoted in fractions of 1/10,000; +20 points would mean add 0.002 to the spot rate. As an example, if an investor wished to purchase Australian dollars (AUD) using a forward currency contract, and was quoted AUD at 0.9000 minus 55.55 points, the forward rate would be 0.894445.
Forward Rates
1. U.S. Dollar/Japanese Yen(^USDJPY)
FORWARD RATESfor Fri, Feb 15th, 2019
Name
Bid
Ask
USD/JPY 1-Year Forward
-334.000
-333.000
2. British Pound/Japanese Yen(^GBPJPY)
FORWARD RATESfor Fri, Feb 15th, 2019
Name
Bid
Ask
GBP/JPY 1-Year Forward
-180.830
-177.380
3. Australian Dollar/Japanese Yen(^AUDJPY)
FORWARD RATESfor Fri, Feb 15th, 2019
Name
Bid
Ask
AUD/JPY 1-Year Forward
-196.950
-194.730
4.U.S. Dollar/South African Rand(^USDZAR)
FORWARD RATESfor Fri, Feb 15th, 2019
Name
Bid
Ask
USD/ZAR 1-Year Forward
6,488.99951
6,560.99951
Select World 1 year Interest Rates - Financial Times
Source:https://markets.ft.com/data/bonds
Bonds Interest Rates
Latest
Australia
1.51%
Japan
0.00%
South Africa
6.08%
United Kingdom
0.55%
United States
2.35%
FOREIGN EXCHANGE FUTURES Quotes
1. South African Rand Mar '19(T6H19)
0.070675s+0.000175(+0.25%)02/15/19[CME]
FUTURES CONTRACTSfor Fri, Feb 15th, 2019
Contract
Last
T6G20 (Mar '20)
0.067825s
2.Australian Dollar Mar '19(A6H19)
0.71430s+0.00340(+0.48%)02/15/19[CME]
FUTURES CONTRACTSfor Fri, Feb 15th, 2019
Contract
Last
A6H20 (Mar '20)
0.71820s
3.Japanese Yen Mar '19(J6H19)
0.907300s+0.000200(+0.02%)02/15/19[CME]
FUTURES CONTRACTSfor Fri, Feb 15th, 2019
Contract
Last
J6H20 (Mar '20)
0.935450s
4.British Pound Mar '19(B6H19)
1.2905s+0.0086(+0.67%)02/15/19[CME]
FUTURES CONTRACTSfor Fri, Feb 15th, 2019
Contract
Last
B6H20 (Mar '20)
1.3135s
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started