1. An American firm has just bought merchandise from a British firm for £50,000 on terms of 90-day payment. This firm has purchased a 3-month call option on 50,000 pounds at a strike price of $1.7 per pound and a premium cost of $0.02 per pound. On the day the option matures, the spot exchange rate is $1.8 per pound. What will be the value of the pound payable in U.S. dollars, if the U.S. firm exercises the option?

a. $91,000

b. $86,000

c. $85,000

d. $81,000

And why?

2. Assume that the United States faces a 5 percent inflation rate while the U.K has a 7 percent inflation rate. According to the relative PPP, the dollar would be expected to:

a. appreciate by 2 percent against the British pound

b. depreciate by 2 percent against the British pound

c. appreciate by 12 percent against the British pound

d. depreciate by 12 percent against the British pound

And why?