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
Sample Solution