Arbitrage  

BAFI1002 Financial Markets – Group Assignment (Stage 2)

 

Overview

 

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Your team works for a renowned FX trading company, Snowy River Ltd. The company specialises in trading major currencies such as Australian Dollar (AUD), British Pound (GBP), Canadian Dollar (CAD), Euro (EUR), Japanese Yen (JPY), New Zealand Dollar (NZD), Swiss Franc (CHF) and US Dollar (USD). The company also trades various foreign exchange related derivatives for its clients. In addition, it provides general advice to other clients who trade for themselves. The firm’s chief trading executive, Pete Fernandes, has requested your team’s expertise in trading foreign currencies in order to improve firm’s trading strategy and profits. You have been asked to prepare a detailed report in this regard. In your report you must address the following scenarios:

Scenario 3 Arbitrage                                     [7 marks]

 

The firm’s senior management has taken note of your expertise in arbitrage trading. You have been asked to identify potential arbitrage opportunities based on the differences in implied forward rates and actual forward rates. Suppose that the actual forward rates for the end of September 2021 are as presented in Table 4.

Calculate the implied forward rates for the given three pair currencies, and inform the company whether the commodity currencies listed in Table 4 are over-, under-, or fairly valued compared to the implied forward rates you calculated [2 Marks], and which bank will you trade with and what is your suggested strategy to the top management (buy or sell the commodity currency)? [2 Marks].

If there is any arbitrage opportunity available between the implied forward rates and the actual forward rates listed in Table 4, how much profit can you generate for the company as a price taker with 50,000,000 units of currency (choose the most profitable option) [2 Marks]. To minimise the transaction costs involved you can only exploit arbitrage opportunities between two exchange rates (i.e., No Triangular Arbitrage opportunity allowed). Finally, you must convert profit, if any, to AUD using the mid rates estimated in implied forward rates [1 Mark].

 

 

 

 

 

 

 

 

Currency Pairs Bank A Bank B Bank C
Comm / Terms Bid Ask Mid Bid Ask Mid Bid Ask Mid
AUD/USD 0.7355 0.7357 0.7356 0.7354 0.7357 0.7356 0.7356 0.7359 0.7358
AUD/EUR 0.6225 0.6227 0.6226 0.6223 0.6229 0.6226 0.6224 0.6228 0.6226
EUR/AUD 1.6063 1.6066 1.6065 1.6063 1.607 1.6067 1.6060 1.6068 1.6064
AUD/GBP 0.5313 0.5316 0.5315 0.5310 0.5316 0.5313 0.5312 0.5319 0.5316
GBP/AUD 1.8808 1.8813 1.8811 1.8808 1.8816 1.8812 1.8805 1.8815 1.8810
AUD/JPY 80.80 80.83 80.82 80.78 80.84 80.81 80.79 80.86 80.83
EUR/USD 1.1814 1.1816 1.1815 1.1811 1.1816 1.1814 1.1812 1.1819 1.1816
GBP/USD 1.3839 1.3843 1.3841 1.3837 1.3844 1.3841 1.3838 1.3846 1.3842
USD/JPY 109.93 109.94 109.94 109.90 109.95 109.93 109.90 109.95 109.93
EUR/GBP 0.8538 0.8543 0.8541 0.8536 0.8545 0.8541 0.8537 0.8545 0.8541
EUR/JPY 129.79 129.83 129.81 129.75 129.84 129.80 129.77 129.87 129.82
GBP/JPY 152.09 152.14 152.12 152.04 152.16 152.10 152.05 152.15 152.10
AUD/CAD 0.9332 0.9335 0.9334 0.9330 0.9338 0.9334 0.9329 0.9337 0.9333
EUR/CHF 1.0839 1.0848 1.0844 1.0837 1.0848 1.0843 1.0836 1.0847 1.0842
GBP/CHF 1.2696 1.2701 1.2699 1.2695 1.2702 1.2699 1.2693 1.2700 1.2697
USD/CHF 0.9176 0.9179 0.9178 0.9174 0.9180 0.9177 0.9175 0.9181 0.9178
USD/CAD 1.2689 1.2693 1.2691 1.2687 1.2694 1.2691 1.2687 1.2694 1.2691
NZD/USD 0.7113 0.7114 0.7114 0.7110 0.7116 0.7113 0.7111 0.7115 0.7113

Table 1: Exchange rates on 1st August, 2021. Mid rate = (bid rate + ask rate)/2

 

 

 

Currency Opening Position (current) Position in AUD (Current) Net

Trades

Net Position (Expected) Net Position in AUD (Expected) Change in Position (AUD)
AUD            
CAD            
CHF            
EUR            
GBP            
JPY            
NZD            
USD            
Net Position (AUD)            

Table 2: FX portfolio position summary

Note: Indicate long positions with a positive sign and short positions with a negative sign (e.g. a short position of 45,000,000 GBP should be indicated as –-45,000,000). Mid rate = (bid rate + ask rate)/2

 

 Currency Benchmark Interest Rates 2-Month Benchmark Rates

(%)

AUD 2-Month Bank Bill Swap Rates 0.095
GBP 2-Month GBP LIBOR 0.073
CAD 2-Month Treasury Bills 0.150
EUR 2-Month Euro LIBOR -0.495
NZD 2-Month Bank Bill Yields 0.270
CHF 2-Month CHF LIBOR -0.744
JPY 2-Month JPY LIBOR -0.059
USD 2-Month USD LIBOR 0.205

Table 3: Benchmark interest rates on August 1, 2021.

 

 

 

 

 

Comm / Terms Bid Ask Opinion

(over/under/ fairly valued)

Suggested Strategy
AUD/CAD 0.9345 0.9349    
GBP/USD 1.3858 1.3865    
NZD/USD 0.7014 0.7103    

Table 4: Actual forward FX rates for the end of September 2021.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Formatting & Presentation                                           [2 marks]

The report must be professionally presented using Times New Roman, size12 font, double-spaced for the main text, and single spaced for tables, figures & appendices. Figures and graphs should be clearly labelled and numbered. Any information obtained from sources external should be referenced according to AGPS Harvard Style or APA style. A word limit of maximum of 2500 words applies with a tolerance of + 10%, excluding appendices and tables.

Submission

  1. Students are required to register their groups online via Canvas.
  2. Go to the course site on Canvas. Submit your assignment under the submission point. Only one submission is required per group. It’s the responsibility of the group members to ensure that the assignment is submitted on time.
  3. The report must have the university prescribed cover sheet and the following details:
  • Student names and student numbers of those who have contributed to the report
  • FX Session attended
  • Assignment Group Number
  • Name of FX Session Instructor

Feedback & Marking

A rubric with marking criteria will be made available on Canvas. You are strongly encouraged to ask questions during the FX sessions and other learning activities so that you can obtain feedback on your understanding of the concepts and issues being discussed. FX sessions running in week 8 will focus specifically on the discussion of this assignment and related concepts.  Questions specific to this assessment should be addressed to your session instructor. Contact details can of all instructors can be found on Canvas

 

 

 

 

Late Submissions

Late submissions of assignments without special consideration or extension will be automatically penalised at a rate of 10% of the total marks available per day (or part of a day) late. For example, if an assignment is worth 20 marks and it is submitted 1 day late, a penalty of 10% or 2 marks will apply. This will be deducted from the assessed mark. Assignments will not be accepted if more than five days late, unless special consideration or an extension of time has been approved.

Special consideration is available for unexpected circumstances outside students’ control. For more. More information regarding special consideration is available at https://www.rmit.edu.au/students/student-essentials/assessment-and-exams/assessment/extensions-of-time-for-submission-of-assessable-work