IRP, PPP, and Speculating in Currency Derivatives.
The U.S. three-month interest rate (unannualized) is 2%. The Canadian three-month interest rate (unannualized) is 3%. Assume interest rate parity exists. The expected inflation over this period is 5% in the U.S. and 3% in Canada. A call option with a three-month expiration date on Canadian dollars is available for a premium of $.03 and a strike price of $.58. The spot rate of the Canadian dollar is $.60. Assume that you believe in purchasing power parity.
Determine the dollar amount of your profit or loss from buying a call option contract specifying $90,000 Canadian dollars.
The expected change in the Canadian dollar’s spot rate is __________________
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