IRP, PPP, and Speculating in Currency Derivatives. The U.S. three-month interest

Question

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 __________________

PLEASE SHOW DETAILED WORK

Explanation / Answer

Therefore, the expected spot rate in 3 months is $.60 × (1.0194) =.61164

The expected change in the Canadian dollar’s spot rate is: (1.05)/(1.03) – 1 =1.94%

Therefore, the expected spot rate in 3 months is $.60 × (1.0194) =.61164

the net profit per unit on a call option is $.61664 – $.58– $.03 = $.00911.=.00664 For the contract, the net profit is $.00664 × 90,000 = $597.6

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.