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)

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. 

2. MAJOR TASK DETAILS

Background           Work -         Data Collection 

The task requires you to collect the following data from various open sources.  

• Collect monthly spot exchange rate between AUD/USD pair over last five years (60 data points)
• Collect quarterly future exchange rate^[1] between AUD/USD pair over last five years over las five years (20 data points). 
• Collect the monthly interest rate and inflation rate for both the USA and Australia. 

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. 

Summary statistics

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.  

Examining the Behavior of the Exchange Rate

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.  

Evaluating the Future Exchange Rate

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. 

Testing IRP, PPP, and IFE

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.   

3. DETAILED REPORT & STRUCTURE

Cover Page 

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

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.  

Executive Summary

The executive summary should contain key highlights of the report. 

Introduction

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. 

Data and Summary Stats 

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. 

Exchange Rate Behavior 

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. 

Future Exchange Rate

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. 

Conclusion

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. 

References 

Follow APA style of referencing within the body of the text and in the reference section for all sources of information. 

Appendices 

This section should include any appendix tables. graphs that have not been presented in the text or the excel sheet. 

4. ADDITIONAL FORMATTING NOTES

• The report should be concise.
• The main body should be around 1200 words + / - 5%. 
• A4 page, 1.5 spaced, professional font with size 12. 
• Use suitable colour in a consistent way that improves readability and consistency in presentation [Consider vision impact in choosing colour]
• Make an appropriate decision regarding what to put in the main body of the report in answering each section and what to put in the appendices or the Excel file. For example, putting a large table in the body of the report is not a good choice or missing a key table in the body of the report represents equally poor judgment. 
• Materials presented in appendices will not be considered for marking purposes. Markers will consult the appendices to check the authenticity and correctness of the information presented in the main text of the report. The absence of such support in the appendices / Excel file will count against the mark.
• Each table, figure, and graph should be self-explanatory. Readers should be able to understand what that particular table or figure is about and, what is the measurement scale and what it represents.  See the graph from an IMF report, as an example. The graph has a caption, appropriate level data points, sources, any notes to help improve readability and understanding.  
• The Excel / Number file document should be neatly formatted. Use the separate worksheet in the same file for different tables, graphs, etc. Some graphs/tables that you will present in the main text should also be present in the Excel file. 

5. SUBMISSION DETAILS

• Due date: 18^th of April 2021 before 11.50 pm. 
• The soft copy (MS Word / PDF file and Excel file) of the written report will be submitted online via a link in the Assignment section on LMS. The link for soft copy submission will be available 3 days before the submission deadline.  
• For academic integrity and training future equity analysts who will show confidence and independence, Turnitin will be used to report text matching. Each student will be able to resubmit the report as many times as they wish until the report due date. Each student should note that the Turnitin text-matching report showing the percentage of each student’s work matching with other sources, including the work of other students in the cohort, past and present students at La Trobe, and other online materials. Turnitin matching percentage of more than 20% will result in the rejection of the submission.  
• In the case of two matched reports (no determination will be made about the original document) and following the academic integrity module both teams will be equally penalized (or both reports will be rejected).
• During high traffic, Turnitin will take time to generate the matching report. You may want to submit the final report early (before the actual deadline) to allow sufficient time for LMS to generate the Turnitin report. 
• Special consideration will not be accepted for this task except for the current COVID 19 pandemic unless some member has fallen ill. Late submission will be assessed on 70% of the overall marks.  
• An Excel spreadsheet with all analyses conducted for the report should also be submitted. Please make sure the Excel file is presentable.
• The word count is limited to the main repot excluding cover page, table of contents, reference, and appendices. Distribute the word count according to the marking weight for each section of the report. 
• Start a new section on a new page of the report. 

6. PLAGIARISM

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]: