What are the principles of the carry trade

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Reference no: EM131049209

Question 1:

Working for GLB Ltd. Treasury Division, an Australian exporter of airport surveillance systems, one day you are asked to find an avenue to invest your company's surplus funds over one year. Based on the in-house research, your company anticipates a 1% increase in the curve in six months. The 6-month and 1-year zero-coupon rates are respectively 3% and 3.2%. After doing some research yourself, you find two different opportunities:

- your company can buy the 1-year zero-coupon T-bond and hold it until maturity;
- or your company can choose a rollover strategy by buying the 6-month T-bill, holding it until maturity, and buying a new 6-month T-bill in six months, and holding it until maturity.

1. Calculate the annualized total return rate of these two strategies assuming that your company's anticipation is correct.

2. Same question when interest rates decrease by 1% after six months.

Question 2:

As an analyst for Vandelay Bank Treasury Department, your supervisor has handed you a chart (Figure 1) showing a recent spike of the Euro against the US dollar. You are asked to write a report:

2476_Calculate the annualized total return rate.jpg

(a) to examine and investigate the background and reasons (the risk factors) behind this dramatic forex rate spike. What are the reasons, if any, resulting in the exchange rate spike on April 3, 2015?

(b) to assess the forex rate spike within the context of fundamental analysis of forex rate.

(c) to discuss the likely fundamental impacts on the most traded currency pair in the world, EUR/USD over the next six months. Include a screenshot of the EUR/USD over the last six months and comment on the movements. (Hint: if you have no other sources for data, you can download a forex trading platform that will give you real live data. The platform is known as MT4. There are many brokers however, I recommend you download from Alpari - www.alpari.com or FXDD, www.fxdd.com. Only a DEMO account (it is free) is needed. Use the demo platform to take a screenshot.)

Question 3:

(a) In recent years there has been an increase in the use of technical analysis techniques to trade foreign currencies as distinct from manage foreign currency risk. Explain how traders use technical analysis, use an example to illustrate, and distinguish between "trading currencies" and "managing foreign currency risk".

(b) It is incredibly difficult to arbitrage exchange rates as liquidity on the major currencies is so large and relevant information is impounded into the exchange rate instantaneously. However, there is a strategy known as the "Carry Trade" - this trade was very popular in the last ten years between the Japanese yen and the USD, and recently between the euro and the AUD.

(i) What are the principles of the carry trade?

(ii) Construct an example using past data to show a "carry trade" and clearly show the risks.

Question 4:

Using the following quotation method, i.e. indirect AUD 1 = USD 0.8000 as the spot.

(a) Source the cash rates for the AUD and USD to calculate the one year forward rate. Use todays spot rate. Why do you think a forward exchange contract is the most popular hedging instrument? (Assume a 360-day year.)

(b) Is this rate at a discount or a premium to the AUD? Explain the theory and practice of the relationship.

(c) "The spot rate in one year will probably be entirely different to the one year forward rate". Is this statement true? Explain and source data to support your analysis.

(d) Assume the AUDUSD spot is 0.7748 at present. Evaluate the factors that will likely lead to a strengthening of the spot rate to 0.7808, and alternatively a weakening to 0.6758 over the next twelve months.

Question 5:

This is a team based assignment and in a work environment a team would be involved in completing these tasks. Therefore, you need to demonstrate that you have worked as a team.

Each member of the group is required to submit a reflective report describing the operations of the group. In the report you are required to evaluate the performance of the overall group - how the group was organised, planning, distribution of tasks, how initial answers were reviewed, the problems encountered, solutions, overall effectiveness and what you learned from the group assignment that is relevant in the work environment.

Reference no: EM131049209

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