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1
FINM7406 Semester 1 2025
UQ Business School, University of Queensland
Assignment Overview
This is an individual assignment total of 100 marks counting towards 20% of your final grade.
Assignment due: 15 May 2025 16:00. Submit electronically on Blackboard and Turnitin.
Carry Trade – Uncovered Interest Rate Parity (UIRP) (100 marks)1
Investment currencies and funding currencies: In FINM7406, you learn about uncovered interest
rate parity (UIRP), which states that any difference in interest rates between two countries should be
offset by the appreciation or depreciation of their currencies. From an investment perspective, if UIRP
holds, a simple carry trade strategy—borrowing in low-interest-rate countries and investing in high- interest-rate currencies—would not be profitable. This is because currencies of high-interest-rate
countries would depreciate.
As an FX strategist at one of the world's largest hedge funds (AQR), you aim to evaluate the profitability
of the carry trade strategy across nine currencies: AUD, EUR, CAD, JPY, NZD, SKr, CHF, GBP, and
USD. Follow the steps below to construct the strategy using Excel and answer the corresponding
questions.
1) Ranking: For each month of the sample, rank the countries based on their interest rates. Compute
each country’s average rank (1=lowest interest rate, etc.).
A. Which country has the lowest average rank, i.e., most often “funding currency” with the lowest
interest-rate? Which country is the second to most often funding currency (second lowest
average rank)? (6 marks)
B. Which country is most often “investment currency,” i.e. highest average rank? Which country
is second to most often investment currency? (5 marks)
C.
Plot the rank of the US over time. (5 marks)
2) Carry positions: Create positions for each currency, either $1 (long), $-1 (short), or 0 (flat). Do
this by going short the three currencies with the lowest interest rate, and long the three with the
highest interest rate.
A. What is the average position in Australia and New Zealand? (5 marks)
1 This question is adopted from “Efficiently Inefficient: How Smart Money Invests and Market Prices Are
Determined” (Lasse Heje Pedersen, 2015).
FINM7406 S1 2025 Assignment
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3) Carry trade return: Compute the excess return on each position and add these up to get the excess
return of the entire portfolio in any month. Make sure to get the timing right.
A. What is the annualized average excess return of the portfolio? What is the annualized standard
deviation? What is the annualized SR? What is the skewness of monthly returns? What is the
(excess) kurtosis of monthly return? (8 marks)
4) Transaction costs: For each currency, compute the trade each month (i.e. the change in position
this month, minus last month). Assuming that the transaction costs are proportional as given in the
sheet, compute the transaction costs for each currency. Add up the transaction costs to get the total
transaction costs. Subtract total transaction costs from the portfolio’s excess return to get the return
net of trading costs.
A. What is the annualized average net return of the portfolio? What is the annualized net SR? (8
marks)
5) High water mark (HWM): Compute the portfolio’s total return including the US risk free rate,
but net of transaction costs (i.e. add the annual US interest rate divided by 12 to the portfolio’s
return). Next, compute the cumulative return, assuming you start with $1, and then keep reinvesting
all profits/losses. Further, compute the high-water mark as the maximum cumulative return from
the first date to the current date.
A. Make a plot with both the cumulative return and the high-water mark. (12 marks)
6) Drawdown: Compute and plot the drawdown, DDt = (HWMt – Pt) / HWMt, where P is the
cumulative return and HWM is the high-water mark.
A. What is the maximum drawdown during the period? (7 marks)
Report: Your findings should be compiled into a comprehensive executive report recommending
whether the fund should implement the strategy. Your report should contain responses to the following
questions:
A. Carry trade return: Comment on the findings in 3.A. (10 marks)
B. Transaction costs: Why is the effect of transaction costs calculated in 4.A so modest in this
case? Do you think that this is typical of all trading strategies? Under which circumstances
might a global macro trader incur larger transaction costs in connection with the currency carry
trade? (12 marks)
C. Drawdown: Comment on the drawdown pattern in 6.A (12 marks)
D. Dynamic carry trade: Suggest a way of dynamically timing the carry trade (that is, increasing
and decreasing the position sizes over time) that might improve the performance of the strategy
and/or reduce the drawdowns. (10 marks)
FINM7406 S1 2025 Assignment
3
Submission Info:
Submission:
? Submit one Excel file on Blackboard containing all of the Excel calculations and plots
a. Name the Excel file “FINM7406__Lastname_Studentnumber.xlsx” where Lastname is
your last name, Studentnumber is your student number.
b. You may submit the Excel file as many as you like, but only your last submission will be
graded.
? Submit one executive report on Turnitin and Blackboard:
a. The report needs to thoughtfully link the answers of your Excel calculations.
b. The report needs to contain your own research about Carry Trade strategy. The references
have to come from quality sources including academic journals, industry reports, World
Bank, IMF etc.
c. Name the PDF file “FINM7406__Lastname_Studentnumber.pdf” where Lastname is
your last name, Studentnumber is your student number.
d. Only submit the written report once on Turnitin.
Notes:
? Excel: Your Excel file should include all workings and calculations. Formulas for the calculations
should have cell references wherever possible. If you have computed a number incorrectly and
just typed that number into the spreadsheet (or typed a formula using numbers when cell
references could have been used), you will not receive partial credit for any portion of your
computation that is correct.
? The executive report (maximum 2500 words) in a pdf document is required for Turnitin check.
? References should be in Harvard style. References should come from high quality sources e.g.
academic journals, industry reports, World Bank, IMF, etc.
1
FINM7406 Semester 1 2025
UQ Business School, University of Queensland
Assignment Overview
This is an individual assignment total of 100 marks counting towards 20% of your final grade.
Assignment due: 15 May 2025 16:00. Submit electronically on Blackboard and Turnitin.
Carry Trade – Uncovered Interest Rate Parity (UIRP) (100 marks)1
Investment currencies and funding currencies: In FINM7406, you learn about uncovered interest
rate parity (UIRP), which states that any difference in interest rates between two countries should be
offset by the appreciation or depreciation of their currencies. From an investment perspective, if UIRP
holds, a simple carry trade strategy—borrowing in low-interest-rate countries and investing in high- interest-rate currencies—would not be profitable. This is because currencies of high-interest-rate
countries would depreciate.
As an FX strategist at one of the world's largest hedge funds (AQR), you aim to evaluate the profitability
of the carry trade strategy across nine currencies: AUD, EUR, CAD, JPY, NZD, SKr, CHF, GBP, and
USD. Follow the steps below to construct the strategy using Excel and answer the corresponding
questions.
1) Ranking: For each month of the sample, rank the countries based on their interest rates. Compute
each country’s average rank (1=lowest interest rate, etc.).
A. Which country has the lowest average rank, i.e., most often “funding currency” with the lowest
interest-rate? Which country is the second to most often funding currency (second lowest
average rank)? (6 marks)
B. Which country is most often “investment currency,” i.e. highest average rank? Which country
is second to most often investment currency? (5 marks)
C.
Plot the rank of the US over time. (5 marks)
2) Carry positions: Create positions for each currency, either $1 (long), $-1 (short), or 0 (flat). Do
this by going short the three currencies with the lowest interest rate, and long the three with the
highest interest rate.
A. What is the average position in Australia and New Zealand? (5 marks)
1 This question is adopted from “Efficiently Inefficient: How Smart Money Invests and Market Prices Are
Determined” (Lasse Heje Pedersen, 2015).
FINM7406 S1 2025 Assignment
2
3) Carry trade return: Compute the excess return on each position and add these up to get the excess
return of the entire portfolio in any month. Make sure to get the timing right.
A. What is the annualized average excess return of the portfolio? What is the annualized standard
deviation? What is the annualized SR? What is the skewness of monthly returns? What is the
(excess) kurtosis of monthly return? (8 marks)
4) Transaction costs: For each currency, compute the trade each month (i.e. the change in position
this month, minus last month). Assuming that the transaction costs are proportional as given in the
sheet, compute the transaction costs for each currency. Add up the transaction costs to get the total
transaction costs. Subtract total transaction costs from the portfolio’s excess return to get the return
net of trading costs.
A. What is the annualized average net return of the portfolio? What is the annualized net SR? (8
marks)
5) High water mark (HWM): Compute the portfolio’s total return including the US risk free rate,
but net of transaction costs (i.e. add the annual US interest rate divided by 12 to the portfolio’s
return). Next, compute the cumulative return, assuming you start with $1, and then keep reinvesting
all profits/losses. Further, compute the high-water mark as the maximum cumulative return from
the first date to the current date.
A. Make a plot with both the cumulative return and the high-water mark. (12 marks)
6) Drawdown: Compute and plot the drawdown, DDt = (HWMt – Pt) / HWMt, where P is the
cumulative return and HWM is the high-water mark.
A. What is the maximum drawdown during the period? (7 marks)
Report: Your findings should be compiled into a comprehensive executive report recommending
whether the fund should implement the strategy. Your report should contain responses to the following
questions:
A. Carry trade return: Comment on the findings in 3.A. (10 marks)
B. Transaction costs: Why is the effect of transaction costs calculated in 4.A so modest in this
case? Do you think that this is typical of all trading strategies? Under which circumstances
might a global macro trader incur larger transaction costs in connection with the currency carry
trade? (12 marks)
C. Drawdown: Comment on the drawdown pattern in 6.A (12 marks)
D. Dynamic carry trade: Suggest a way of dynamically timing the carry trade (that is, increasing
and decreasing the position sizes over time) that might improve the performance of the strategy
and/or reduce the drawdowns. (10 marks)
FINM7406 S1 2025 Assignment
3
Submission Info:
Submission:
? Submit one Excel file on Blackboard containing all of the Excel calculations and plots
a. Name the Excel file “FINM7406__Lastname_Studentnumber.xlsx” where Lastname is
your last name, Studentnumber is your student number.
b. You may submit the Excel file as many as you like, but only your last submission will be
graded.
? Submit one executive report on Turnitin and Blackboard:
a. The report needs to thoughtfully link the answers of your Excel calculations.
b. The report needs to contain your own research about Carry Trade strategy. The references
have to come from quality sources including academic journals, industry reports, World
Bank, IMF etc.
c. Name the PDF file “FINM7406__Lastname_Studentnumber.pdf” where Lastname is
your last name, Studentnumber is your student number.
d. Only submit the written report once on Turnitin.
Notes:
? Excel: Your Excel file should include all workings and calculations. Formulas for the calculations
should have cell references wherever possible. If you have computed a number incorrectly and
just typed that number into the spreadsheet (or typed a formula using numbers when cell
references could have been used), you will not receive partial credit for any portion of your
computation that is correct.
? The executive report (maximum 2500 words) in a pdf document is required for Turnitin check.
? References should be in Harvard style. References should come from high quality sources e.g.
academic journals, industry reports, World Bank, IMF, etc.