Covered Interest Rate Parity (30 marks)You are required to investigate whether you can capture an arbitrage opportunity that could arise fromthe violation in Covered Interest Rate Parity (CIP) in USD, EUR, and AUD currency markets. To doso, you need to detect whether such violation in the markets ever happened using daily historical data(interest rates, forward rates, spot rates) from January 2001 to December 2023.Download the data “data.xlsx” from the Assignment Folder.1For each currency pair i.e. USDAUD and USDEUR, complete Task A and Task B:A. Using daily mid rates, calculate the daily deviations from the CIP. Plot the deviations over timefor the entire sample. Report the mean and standard deviation of the deviations for each of thetwo subperiods: January 2001 – December 2007 and January 2008-December 2023. (10 marks)B. Is there any severe violation of the CIP? If there is, choose the day when the largest deviationoccurred and construct a trading strategy to capture the opportunity. The trading strategy shouldbe constructed realistically i.e. bid-ask rates should be considered here.2 How much profitwould you have made? Assume that you first start the position by borrowing 10,000,000 unitsof a currency (USD, AUD or EUR). (5 marks)Provide a written report to answer the following Task C:C. Discuss the potential reasons driving the CIP violation. The report should demonstrate yourcritical assessment whether there were in fact profitable arbitrage opportunities from theviolation? Hint: Look at the time-series plot of the deviation and think about when the CIPviolation tends to happen and why that is the case. Your critical discussion should be supportedby evidence from Parts A and B above, as well as academic and/or industry research

Sure, I can help you with that. Here's a step-by-step guide on how to approach this task:

Step 1: Download the Data First, you need to download the data from the "data.xlsx" file in the Assignment Folder. This data should contain daily historical data (interest rates, forward rates, spot rates) from January 2001 to December 2023 for USD, EUR, and AUD currency markets.

Step 2: Calculate Deviations from CIP For each currency pair i.e. USDAUD and USDEUR, calculate the daily deviations from the Covered Interest Rate Parity (CIP) using the daily mid rates.

Step 3: Plot the Deviations Plot these deviations over time for the entire sample. This will give you a visual representation of the CIP violation over time.

Step 4: Report Mean and Standard Deviation Calculate and report the mean and standard deviation of these deviations for each of the two subperiods: January 2001 – December 2007 and January 2008-December 2023.

Step 5: Identify Severe Violations Identify if there are any severe violations of the CIP. If there are, choose the day when the largest deviation occurred.

Step 6: Construct a Trading Strategy Construct a trading strategy to capture the opportunity from the largest deviation. This strategy should be realistic and consider bid-ask rates.

Step 7: Calculate Potential Profit Calculate how much profit you would have made from this strategy. Assume that you first start the position by borrowing 10,000,000 units of a currency (USD, AUD or EUR).

Step 8: Discuss Potential Reasons for CIP Violation Finally, discuss the potential reasons driving the CIP violation. This should be a critical assessment of whether there were in fact profitable arbitrage opportunities from the violation. Support your discussion with evidence from Parts A and B above, as well as academic and/or industry research.

Remember, this is a complex task that requires a good understanding of financial markets and the concept of Covered Interest Rate Parity. It's important to take your time and carefully analyze the data.