SECTION A Answer ALL questions in Section A. QUESTION ONE You are studying "Interest Rate Parity", a finance theory that the interest rate differential between foreign and domestic countries is equal to the return on the currency exchange rate. To test the theory, you run the following regression model for the currency exchange rate data between 1979 and 2015. The number of observations is 431. fxret, =0.53 + 0.73 rdiff-1. R2 = 0.77 (0.06) (0.02) where fxret is the monthly return of GBPUSD exchange and indiff is the interest rate differential between UK and US. Values in parentheses are standard errors. a) What is the interpretation of the estimated coefficient values 0.53 and 0.73? (5 marks) b) Test the hypothesis that the slope coefficient is equal to 1 (use a two-sided test with a 5% significance level). Clearly state all steps of the testing procedure, all relevant information you use and how you reach your conclusion. (15 marks) c) Based on the outcome of your hypothesis test in part (b), explain if the "Interest Rate Parity" theory is supported by the empirical evidence? (5 marks) d) Now you estimate the following extended regression model that also includes two exchange rate returns: fxret, =0.52 + 0.73 rdiff - -0.01yenret; -1 -0.02chfret; -1, R= =0.79 (0.04) (0.02) (0.01) (0.03) where venret is the YENUSD return and chfret is the CHFUSD return. The R-squared of the new regression model is 0.79. Use this information to test the null hypothesis that coefficients the two new variables are jointly statistically insignificant using the F-test. Clearly state the null and alternative hypotheses, the value of the F-statistic and the critical value you use. Clearly show all steps and explain how you reach your conclusion. (15 marks)TABLE of CRITICAL VALUES for STUDENT'S t DISTRIBUTIONS Column headings denote probabilities ( ) above tabulated values, d.f. 0.40 0.25 0.10 0.05 0.04 0.025 0.02 0.01 0.005 0.0025 0.001 0.0005 0.325 1.000 3.078 6.314 7.916 12.706 15.894 31.821 63.656 127.321 318.289 636.578 0.289 0.816 1.886 2.920 3.320 4.303 4.849 6.965 69.925 14.089 22 328 31.600 3 0.277 0.765 1.638 2.353 2.605 3.182 3.482 4.541 5.841 7.453 10.214 12.924 4 0.271 0.741 1.533 2.132 2.333 2.776 2.999 3.747 4.604 5.598 7.173 8.610 0.267 0.727 1.476 2.015 2.191 2.571 2.757 3.365 4.032 4.773 5.894 6 6.869 0.265 0.718 1.440 1.943 2.104 2.447 2.612 3.143 3.707 4.317 5.208 5.959 0.263 0.711 1.415 1.895 2.046 2.365 2.517 2 998 3.499 4.029 4.785 5.408 8 0.262 0.706 1.397 1.860 2.004 2.306 2.449 2.896 3.355 3.833 4.501 5.041 9 0.261 0.703 1.383 1.833 1.973 2.262 2.398 2 821 3.250 3.690 4.297 4.781 10 0.260 0.700 1.372 1.812 1.948 2.228 2.359 2.764 3.169 3.581 4.144 4.587 1 0.260 0.697 1.363 1.796 1.928 2.201 2 328 2.718 3.106 3.497 4.025 4.437 12 0.259 0.695 1.356 1.782 1.912 2.179 9 2.303 2.681 3.055 3.428 3.930 4.318 13 0.259 0.694 1.350 1.771 1.899 2.160 2.282 2.650 3.012 3.372 3.852 4.221 14 0.258 0.692 1.345 1.761 1.887 2.145 2.264 2.624 2.977 3.326 3.787 4.140 15 0.258 0.691 1.341 1.753 1.878 2.131 2.249 2.602 2.947 3.286 3.733 4.073 0.258 0.690 1.337 1.746 1.869 2.120 2.235 2.583 2.921 3.252 3.686 4.015 17 0.257 0.689 1.333 1.740 1.862 2.110 2.224 2.567 2.898 3.222 3.646 3.965 18 0.257 0.688 1.330 1.734 1.855 2.101 2.214 2.552 2 878 3.197 3.610 3.922 9 0.257 0.688 1.328 1.729 1.850 2.093 2 205 2 539 2 861 3174 3.579 3.883 20 0.257 0.687 1.325 1.725 1.844 2.086 2.197 2.528 2 845 3.153 3.552 3.850 21 0.257 0.686 1.323 1.721 1.840 2.080 2.189 2.518 2 831 3.135 3.527 3.819 22 0.256 0.686 1.321 1.717 1.835 2.074 2.183 2.508 2.819 3.119 3.505 3.792 23 0.256 0.685 1.319 1.714 1.832 2.069 2.177 2.500 2 807 3.104 3.485 3.768 4 0.256 0.685 1.318 1.711 1.828 2.064 2.172 2.492 2.797 3.091 3.467 3.745 25 0.256 0.684 1.316 1.708 1.825 2.060 2.167 2.485 2.787 3.078 3.450 3.725 26 0.256 0.684 1.315 1.706 1.822 2.056 2.162 2.479 2.779 3.067 3.435 3.707 27 0.256 0.684 1.314 1 1.703 1.819 2.052 2.158 2.473 2.771 3.057 3.421 3.689 28 0.256 0.683 1.313 1.701 1 817 2.048 2.154 2.467 2.763 3.047 3.408 3.674 29 0.256 0.683 1.311 1.699 1.814 2.045 2.150 2.462 2.756 3.038 3.396 3.660 30 0.256 0.683 1.310 1.697 1.812 2.042 2.147 2.457 2.750 3.030 3.385 3.646 31 0.256 0.682 1.309 1.696 1 810 2.040 2.144 2.453 2.744 3.022 3.375 3.633 0.255 0.682 1.309 1.694 1.808 2.037 2.141 2.449 2.738 3.015 3.365 3.622 33 0.255 0.682 1.308 1.692 1.806 2.035 2.138 2.445 2.733 3.008 3.356 3.611 34 0.255 0.682 1.307 1.691 1.805 2.032 2.136 2.441 2.728 3.002 3.348 3.601 35 0.255 0.682 1.306 1.690 1.803 2.030 2.133 2.438 2.724 2.996 3.340 3.591 36 0.255 0.681 1.306 1.688 1.802 2.028 2.131 2.434 2.719 2.990 3.333 3.582 37 0.255 0.681 1.305 1.687 1.800 2.026 2.129 2.431 2.715 2.985 3.326 3.574 38 0.255 0.681 1.304 1.686 1.799 2.024 2.127 2.429 2.712 2.980 3.319 3.566 39 0.255 0.681 1.304 1.685 1.798 2.023 3 2.125 2.426 2.708 2.976 3.313 3.558 40 0.255 0.681 1.303 1.684 1.796 2.021 2.123 2.423 2.704 2.971 3.307 3.551 60 0.254 0.679 1.296 1.671 1.781 2.000 2.099 2.390 2.660 2.915 3.232 3.460 0.254 0.678 1.292 1.664 1.773 1.990 2.088 2.374 2.639 2.887 3.195 3.416 100 0.254 0.677 1 1.290 1.660 1.769 1.984 2.081 2.364 2.626 2 871 3.174 3.390 120 0.254 0.677 1.289 1.658 1.766 1.980 2.076 2 358 2.617 2.860 3.160 3.373 140 0.254 0.676 1.288 1.656 1.763 1.977 2.073 2.353 2.611 2.852 3.149 3.361 160 0.254 0.676 1.287 1.654 1.762 1.975 2.071 2.350 2.607 2.847 3.142 3.352 180 0.254 0.676 1.286 1.653 1.761 1.973 2.069 2347 2.603 2 842 3.136 3.345 200 0.254 0.676 1.286 1.653 1.760 1.972 2.067 2.345 2.601 2.838 3.131 3.340 250 0.254 0.675 1.285 1.651 1.758 1.969 2.065 2.341 2.596 2.832 3.123 3.330 inf 0.253 0.674 1.282 1.645 1.751 1.960 2.054 2.326 2.576 2 2 807 3.090 3.290F - Distribution (( = 0.05 in the Right Tail) df Numerator Degrees of Freedom 2 6 7 8 N 161.45 199.50 215.71 224.58 230.16 233.99 236.77 238.88 240.54 18.513 19.000 19.164 19.247 19.296 19.330 19.353 19.371 19.385 10.128 9.5521 9.2766 9.1172 9.0135 8.9406 8.8867 8.8452 8.8123 7.7086 9.9443 6.5914 6.3882 6.2561 6.1631 6.0942 6.0410 5.9988 6.6079 5.7861 5.4095 5.1922 5.0503 4.9503 4.8759 4.8183 4.7725 5.9874 5.1433 4.7571 4.5337 4.3874 4.2839 4.2067 4.1468 4.0990 5.5914 4.7374 4.3468 4.1203 3.9715 3.8660 3.7870 3.7257 3.6767 5.3177 4.4590 4.0662 3.8379 3.6875 3.5806 3.5005 3.4381 3.3881 5.1174 1.2565 3.8625 3.6331 3.4817 3.3738 3.2927 3.2296 3.1789 4.9646 4.1028 3.7083 3.4780 3.3258 3.2172 3.1355 3.0717 3.0204 4.8443 3.9823 3.5874 3.3567 3.2039 3.0946 3.0123 2.9480 2.8962 4.7472 3.8853 3.4903 3.2592 3.1059 2.9961 2.9134 2.8486 2.7964 4.6672 3.8056 3.4105 3.1791 3.0254 2.9153 2 8321 2.7669 2.7144 4.6001 3.7389 3.3439 3.1122 2.9582 2.8477 2.7642 2.6987 2.6458 4.5431 3.6823 3.2874 3.0556 2.9013 2.7905 2.7066 2.6408 2.5876 4.4940 3.6337 3.2389 3.0069 2.8524 2.7413 2.6572 2.5911 2.5377 Denominator Degrees of Freedom 4.4513 3.5915 3.1968 2.9647 2.8100 2.6987 2.6143 2.5480 2.4943 4.4139 3.5546 3.1599 2.9277 2.7729 2.6613 2.5767 2.5102 2.4563 4.3807 3.5219 3.1274 2.8951 2.7401 2.6283 2.5435 2.4768 2.4227 4.3512 3.4928 3.0984 2.8661 2.7109 2.5990 2.5140 2.4471 2.3928 4.3248 3.4668 3.0725 2.8401 2.6848 2.5727 24876 2.4205 2.3660 4.3009 3.4434 3.0491 2.8167 2.6613 2.5491 2.4638 2.3965 2.3419 4.2793 3.4221 3.0280 2.7955 2.6400 2.5277 2.4422 2.3748 2.3201 4.2597 3.4028 3.0088 2.7763 2.6207 2.5082 2.4226 2.3551 2.3002 4.2417 3.3852 2.9912 2.7587 2.6030 2.4904 2.4047 2.3371 2.2821 4.2252 3.3690 2.9752 2.7426 2.5868 2.4741 2.3883 2.3205 2.2655 4.2100 3.3541 2.9604 2.7278 2.5719 2.4591 2.3732 2.3053 2.2501 4.1960 3.3404 2.9467 2.7141 2.5581 2.4453 2.3593 2.2913 2.2360 4.1830 3.3277 2.9340 2.7014 2.5454 2.4324 2.3463 2.2783 2.2229 4.1709 3.3158 2.9223 2.6896 2.5336 2.4205 2.3343 2.2662 2.2107 4.0847 3.2317 2.8387 2.6060 2.4495 2.3359 2.2490 2.1802 2.1240 4.0012 3.1504 2.7581 2.5252 2.3683 2.2541 2.1665 2.0970 2.0401 3.9201 3.0718 2.6802 2.4472 2.2899 2.1750 2.0868 2.0164 1.9588 3.8415 2.9957 2.6049 2.3719 2.2141 2.0986 2 0096 1.9384 1.8799