The U.S. three-month interest rate (annualized) is 2%. The British pound three-month interest rate (annualized) is 3.5%. Assume interest rate parity exists. The expected inflation over this period is 6% in the U.S. and 2% in England. A call option with a three-month expiration date on British pounds is available for a premium of $.02 and a strike price of $.63. The spot rate of the British pound is $.61. Assume that you believe in purchasing power parity.
Determine the dollar amount of your profit or loss from buying a call option contract specifying $104,000 British pounds.
ANSWER: The expected change in the British pound’s spot rate is: ______________________
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