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FX market is considered as the most perfect market in the world where we can expect to hold
the law of one price. The law of one price provided theoretical base for all international parity
conditions. International parity conditions can be used to understand the operational
behaviour of the foreign exchange market. In a perfect market, all these parity conditions
should be held and there will be no possibility of abnormal profit on arbitrage or speculation.
The aim of this group assignment is to give you an opportunity to empirically investigate the
existence of some of those parity conditions.
This assignment consists of two tasks, as described below:
Task one: Factors affecting the foreign exchange market – (10% Marks)
1. You are required to collect data on historical foreign exchange rate for 10 selected
currencies against the Australian dollar (see the attached link for sources of historical
FX rates) for the period of 01/02/2011 -29/02/2012 (one year).
2. Plot the collected data on a graph showing the daily movements in FX rates (you can
plot all data in one chart or use several charts, if the magnitude of the rates varies
widely).
3. Identify the significant movement of FX rates during the last year of your data and
explain possible reasons for those movements (you are required to cite all your
sources).
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4. Discuss how those foreign exchange movements have affected the economy in
general (you can use any other information such as trade statistics to justify your
explanations).
5. Estimate the correlation coefficient for each pair of currency. What can you learn
from the estimated correlation coefficients? Explain, how you (assuming that you are
a financial controller of a large MNC which having cash flows in all currencies) can
use the estimated correlation coefficient to manage the foreign exchange rate
exposure.
Task two: Forecasting foreign exchange rates (10% Marks)
1. Select five currencies on which you have already collected data and find
corresponding national interest rates and inflation rates information from respective
official sources (such as reserve banks or IMF).
2. Based on the spot exchange rates on 1st February, 2011, estimate the expected
exchange rates for each currency units in one month, three months, six months and
one year using the power purchase parity and International Fischer Effect.
3. Compare your estimated spot exchange rates with the corresponding actuals rates. Are
they different to the actuals? Explain why.
4. Using your findings explain whether there were any possibility to make a profit on
arbitrage or on speculations in the FX market.
Your findings should be presented as a report. All sources of information (such as bank
names, text books, websites with addresses, etc) which you used to prepare your report
should be cited appropriately. (You must attach the FX data tables and other relevant
graphs with the soft copy of your report).
(Word requirements for the report–2,000 (Maximum/excluding statistical data))
Useful website
http://www.westpac.com.au/
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http://www.commbank.com.au/
www.bloomberg.com
www.ozforex.com.au
WWW.CME.COM
www.dailyfx.com
www.forextrading.com.au
http://www.oanda.com
http://www.rba.gov.au/statistics/hist-exchange-rates/index.html
http://www.imf.org/external/data.htm
http://www.imf.org/external/data.htm
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