The U.K. pound is trading at 1.54 Canadian dollars per U.K. pound. There is purchasing power parity at this exchange rate. The interest rate in Canada is 2 percent a year and the interest rate in the United Kingdom is 4 percent a year.
a. Calculate the Canadian interest rate differential.
b. What is the U.K. pound expected to be worth in terms of Canadian dollars one year from now?
c. Which country more likely has the lower inflation rate? How can you tell?