34 IRP, PPP, and speculating in currency derivatives.

The UK three-month interest rate (unannualized)

is 1%. The Canadian three-month interest rate

(unannualized) is 4%. Interest rate parity exists. The expected inflation over this period is 5% in the United Kingdom and 2% in Canada. A call option with a three-month expiration date on Canadian dollars is available for a premium of £0.02 and a strike price of

£0.44. The spot rate of the Canadian dollar is £0.45.

Assume that you believe in purchasing power parity.

a Determine the pound amount of your profit or loss from buying a call option contract specifying C$100 000.

b Determine the pound amount of your profit or loss from buying a futures contract specifying C$100 000.