The ways speculator would help in relieving of the tight condition.

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Chapter 19, Problem 7DQ

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To describe: The ways speculator would help in relieving of the tight condition.

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Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $3.20. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $3.30 per pound. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability. Required: Estimate your exposure (b) to the exchange risk. Note: Negative amount should be indicated by a minus sign. Compute the variance of the dollar value of your property that is attributable to exchange rate uncertainty.

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Suppose that you hold a piece of land in the City of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that, if the British economy booms in the future, the land will be worth £20 and one British pound will be worth $1.29. If the British economy slows down, on the other hand, the land will be worth less, i.e., £24 million, but the pound will be stronger, i.e., $1.4/£. You feel that the British economy will experience a boom with a 70% probability and a slow-down with the remaining probability. Estimate the exposure b to the exchange risk. (USD, no cents)