Conditional on Covered Interest Rate Parity (CIRP) holding, Uncovered Interest Rate Parity (UIRP) holds if and only if the domestic currency is expected to depreciate when the foreign currency trades at a premium in the forward market.Group of answer choicesTrueFalse

Which of the following statement(s) is (are) TRUE?Select one or more alternatives:Investing in a country with a higher interest rate does not secure higher returns because the currency in a high-interest-rate country is expected to depreciate and reduce the profit.The law of one price means that the return from a dollar invested in home currency should be equivalent to the return from a dollar invested in foreign currency together with a long home currency forward contract, if the covered interest rate parity (CIP) condition holds.If the uncovered interest rate parity (UIP) condition holds then it is possible to profit using a carry trade (by borrowing in a low interest rate currency and investing in a high interest rate currency).Forward rate is an unbiased predictor of future spot rate if covered interest rate parity condition holds.

Therefore, according to the uncovered interest parity condition, the domestic interest rate should be equal to the foreign interest rate (r*). If the domestic interest rate were higher than the foreign interest rate, investors would buy the domestic currency to take advantage of the higher interest rate, which would put upward pressure on the domestic currency and violate the fixed exchange rate.

From the covered interest parity, we know that when the forward premium for the home currency against a foreign currency, F(home/foreign), is positive, the domestic interest rate should be: Question 2 Answer a. less than the foreign interest rate. b. greater than the foreign interest rate. c. less than the forward premium. d. greater than the forward premium.

Covered Interest Rate Parity (30 marks)You are required to investigate whether you can capture an arbitrage opportunity that could arise fromthe violation in Covered Interest Rate Parity (CIP) in USD, EUR, and AUD currency markets. To doso, you need to detect whether such violation in the markets ever happened using daily historical data(interest rates, forward rates, spot rates) from January 2001 to December 2023.Download the data “data.xlsx” from the Assignment Folder.1For each currency pair i.e. USDAUD and USDEUR, complete Task A and Task B:A. Using daily mid rates, calculate the daily deviations from the CIP. Plot the deviations over timefor the entire sample. Report the mean and standard deviation of the deviations for each of thetwo subperiods: January 2001 – December 2007 and January 2008-December 2023. (10 marks)B. Is there any severe violation of the CIP? If there is, choose the day when the largest deviationoccurred and construct a trading strategy to capture the opportunity. The trading strategy shouldbe constructed realistically i.e. bid-ask rates should be considered here.2 How much profitwould you have made? Assume that you first start the position by borrowing 10,000,000 unitsof a currency (USD, AUD or EUR). (5 marks)Provide a written report to answer the following Task C:C. Discuss the potential reasons driving the CIP violation. The report should demonstrate yourcritical assessment whether there were in fact profitable arbitrage opportunities from theviolation? Hint: Look at the time-series plot of the deviation and think about when the CIPviolation tends to happen and why that is the case. Your critical discussion should be supportedby evidence from Parts A and B above, as well as academic and/or industry research

Today, the annual interest rate on bank deposits is 8.15% in New York and 3% in Paris, the spot exchange rate is 1.2 US dollars per euro, and the one-year forward exchange rate is 1.236 US dollars per euro. Emily plans to deposit 1,000 US dollars in either New York or Paris for one year. Answer the following questions, using the exact equations for the UIP/CIP.(a). Where should Emily deposit her funds? Given today's spot exchange rate and interest rates, what is the equilibrium forward rate, if covered interest parity (CIP) holds? Report the intermediate steps. [3 marks](b). Suppose the forward rate takes the value given by your answer to question (a). If UIP also holds, is the US dollar expected to appreciate or depreciate against the euro over one year? By how much? Report the intermediate steps.  [3 marks]