Risk premia in Foreign Exchange Market

1.1 Data (Financial Times)
St, Ft, Ft3->excel
1.2 Stata rewrite programme
?Figure 1: exchange rate (Line chart)
?Figure 2: Forward discount (Line chart)
Statistics (Rewrite)
1.3 Analysis the figure, use money demand curve, like Y=C+I+G+NX and plus graph). These should consider conditions of country.
1.4 Figure 2, a forward discount always means positive plus reasons,
1.5 Rewrite summary of statistics table (seminar slides “Test for risk prema in foreign exchange market” P15)
1.6
Analysis formula, weather a and ß is significantly different from zero (seminar slides “introduction to stata-z”P8)->UIP&CIP hold or does not hole

1.7 Use Profit=(1+i1)Ft/St-(1+i $) analysis evidence for the present of risk premia,

1.8 Suppose there is an anticipate increase in future TFP in a count (PPT: Topic Two: more in the open economy)

These should be include in the report.

FIN9003M International Finance Assessment (Resit)
Unit Title: International Finance
Subject: Finance
Department: Lincoln Business School

Hand-in Date: 1st August, 2014

The resit will be assessed by the equivalent of one 4,000 word written individual
assignment. Please submit a hard copy to the faculty office and also email all
documents (assignment report, dataset, and program) to mlin@lincoln.ac.uk by 1stAugust, 2014.

A. Learning outcomes covered
1. Critically discuss the relationship between exchange rates, interest rates, and prices
using models of exchange rate determination.
2. Evaluate the determination of current account and international business comovement.
3. Critically review the operation of the exchange rate systems.
4. Predict and critically assess the financial and macroeconomic impacts of exchange
rate fluctuations and exchange rate policies.

B. Assessment
The assessment consists of two parts, namely empirical study and small essay. Each
part accounts for 50% of the final mark of this module. The required word count is
4,000 words in total excluding tables and graphs. This represents 2,000 words in total
for empirical study and 2,000 equivalent words for small essay. For each part of the
assessment, a 10% + / – on the word limit is acceptable.

Empirical Study:
Please choose ONE of the following questions for your empirical study and prepare a
2,000 word written report. You should submit your dataset and program (in hard copy
and in a CD) with hard copy report for evaluation.

1. Test for Risk Premia in Foreign Exchange Markets1:
FT.com (UK) reports spot and forward exchange rate of other currencies against
US Dollar (USD). You can download these data from FT.com data archive:
http://markets.ft.com/RESEARCH/Markets/Data-Archive.

Choose one out of 35 currencies (SDR not included) for your analysis. Use the data
of last date for each month as monthly data, collect spot rate (denoted as St), 1-
month forward rate (denoted as Ft), and 3-month forward rate (denoted as 3
t F )
from July 2009 to April 2014. Make use of the STATA programs on the
blackboard to prepare answer for the following questions:

a) Produce a graph of the USD/c exchange rate, where c denotes the currency you
have chosen. Provide your comments on the graph. Any abnormal observations
(Outliers)? Double check with the FT.com data archive to make sure these
abnormal observations are not due to the errors you made during the data
collection process. If they are not error inputs, are there any unexpected events
(news) associated with these observations?

READ ALSO : customer value

b) Produce a graph for monthly forward discount ((st??ft)) and provide your
comments, whereSt? log(St ) and ft= log(Ft )

c) Produce a summary statistics table for the variables in your dataset.

d) Download the STATA program ‘ex_risk_premia.do’ from blackboard. Modify
the program to run the following regressions:
Test for the existence of a risk premium on the 1-month horizon by including
the lagged forward discount as a regressor:

Test for the existence of a risk premium on the 3-month horizon by including
the 3-month forward discount, lagged three months, as a regressor:

e) Interpret your regression results. Do you find evidence for the presence of risk
premia in foreign exchange market? Provide your comments on uncovered
interest rate parity (UIP) and covered interest rate parity (CIP) base on your
regression results.

2. Test for Long-run Purchasing Power Parity (PPP)2:

Read Chapter 14 of the following textbook (essential reading of this module):
Robert C. Feenstra and Alan M. Taylor.International Economics. Worth
Publishers: 2nd Revised edition, International Edition (13 April 2011). ISBN-10:
1429269030. ISBN-13: 978-1429269032.

Design a framework to test for absolute PPP and relative PPP following monetary
approach. You should use both graphical illustration and econometric method.
Provide your comment and interpretation on the evidence you find.
Data needed for this question can be found from UNCTAD Statistics website:
http://unctad.org/en/pages/Statistics.aspx.
Your report should contain:

a) Theoretical justification of your framework.
b) Summary statistics of your dataset.
c) Empirical evidence followed by comment and interpretation.

Small Essay:
Please choose ONE of the following questions for your small essay and prepare a
2,000 word written report.
1. Read Chapter 20 of Feenstra and Taylor (2011) textbook and answer the following
questions: Compare and contrast the following scenarios in terms of their costs and
benefits.
a. The central bank uses sterilization bonds to obtain reserves.
b. The central bank follows a strict currency board system.
c. A country maintains a backing ratio that exceeds 100%.
d. The central bank bails out the banking system to avert a financial system crisis.