Part II. Currency Carry Trade (40 marks)
All the questions and requirements are underlined with bold fonts.
In this exercise, we take a look at the currency carry trade. Sheet “Part IIA” includes
the end of month exchange rate between AUD and USD/JPY. The period is 31-Jan1989 to 30-Jul-2021. Sheet “Part IIB” includes the official monthly interest rates for
USA, Japan and Australia. The period is Jan-1990 to Jul-20212
. As the interest rates
are only available from Jan 1990, we will study the period from Jan 1990 to Jul 2021.
1. Report the mean, standard deviation, skewness, kurtosis, and maximum
and minimum of monthly percentage change of the exchange rates
between USD and AUD, JPY and AUD. (5 marks) Note: To be consistent,
we will use the quote 1AUD = USD, and 1AUD = USD in all of the questions
in this part.
2. Report the mean, standard deviation, skewness, kurtosis and maximum
and minimum of the interest rate differences between JPY and AUD, and
between USD and AUD. (5 marks)
3. As in the lecture, we want to take a look at the relative magnitude of changes
in exchange rate and the interest rate differential. Plot the time-series of
percentage changes of AUD-JPY exchange rate and interest rate
difference between JPY and AUD. Then in another graph do the same for
AUD and USD. (10 marks)
4. To explore whether currency carry trade is profitable, we use the following
strategy acting as a Japanese investor. At the end of each month, we borrow 1
million JPY, convert to AUD. Then deposit at AUD interest rate for a month,
after which we convert it back to JPY and pay back our JPY borrowing.
Report the average monthly profits or losses and the standard deviation.
5. (Transaction cost) To see the effect of transaction cost, we assume that the
given exchange rates are bid prices, and the given interest rates are lending
rates. We focus on AUD-JPY trade and assume that the bid-ask spread is 1
JPY. For example, if the bid price is 1 AUD = 100 JPY, the ask rate is 1 AUD
= 101 JPY. Furthermore, the difference between the borrowing and lending
interest rate is 10 basis point. For example, if the lending rate is 3% p.a., the
borrowing rate is 3.1% p.a. Repeat the previous step for JPY and AUD
carry trade. (10 marks)
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