A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1 State 2 State 3 Probability 25% 50% 25% Spot rate $ 2.20 /£ $ 2.00 /£ $ 1.80 /£ P* £ 2,000 £ 2,500 £ 3,000 P $ 4,400 $ 5,000 $ 5,400 Find (a) the expected value of the exchange rate (b) the variance of the exchange rate (c) the covariance of the asset’s ($) price and (the exchange rate)
A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1 State 2 State 3 Probability 25% 50% 25% Spot rate $ 2.20 /£ $ 2.00 /£ $ 1.80 /£ P* £ 2,000 £ 2,500 £ 3,000 P $ 4,400 $ 5,000 $ 5,400 Find (a) the expected value of the exchange rate (b) the variance of the exchange rate (c) the covariance of the asset’s ($) price and (the exchange rate)
Chapter7: International Arbitrage And Interest Rate Parity
Section: Chapter Questions
Problem 51QA
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Question
A U.S. firm holds an asset in Great Britain and faces the following scenario:
|
|
State 1 |
|
State 2 |
|
State 3 |
||||||
|
Probability |
25% |
|
50% |
|
25% |
||||||
|
Spot rate |
$ |
2.20 |
/£ |
|
$ |
2.00 |
/£ |
|
$ |
1.80 |
/£ |
|
P* |
£ |
2,000 |
|
|
£ |
2,500 |
|
|
£ |
3,000 |
|
|
P |
$ |
4,400 |
|
|
$ |
5,000 |
|
|
$ |
5,400 |
|
|
|
Find
(a) the expected value of the exchange rate
(b) the variance of the exchange rate
(c) the covariance of the asset’s ($) price and (the exchange rate)
(d) The "exposure" (i.e. the regression coefficient beta) faced by the firm as a result
( e) Find the cash flow in each of the three states if you implement your (forward) hedge at F1($/£) = $2/£.
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