Study the profitability of currency carry trade strategy using data provided for the currency pair of New Zealand dollar and Japanese yen, and prepare
a report to comment on the validity of the uncovered interest rate parity (UIRP) in this case. Assume that you have the capacity to borrow 100 million
yen at the beginning of each year to conduct currency carry trade by investing in New Zealand dollar for one year. Calculate the total profits from the
carry trade for each year over the period 2000 to 2019, in NZ dollar denomination.
Write an essay to discuss the validity of uncovered interest rate parity based on your findings for the profitability of the carry trade strategy applied to
the NZD-JPY currency pair. Provide an introduction to the concept of currency carry trade and explain the rationale of currency traders pursuing this
strategy. Provide possible explanations for the validity or violation of the uncovered interest rate parity. You may take the perspective of a currency
trader targeting at an audience of clients who are interested in speculating on the foreign exchange market.
Ensure your essay covers at least the following discussion points:
• Prepare a chart plotting past annual change of cross exchange rate between NZD and JAP against the differential interest rates.
• Conduct an ordinary least squares (OLS) regression analysis: regress the annual rate of exchange rate changes on the annual interest rate
differential. Interpret your regression results.
• Assess the profitability of the carry trade strategy based on your calculation results of the profits/losses from the carry trades.
• Does the uncovered IRP hold for the NZD-JAP exchange rate in your opinion?
• What is your recommendation for your clients?
Sample Solution
