A U.S. firm holds an asset in France and faces the following scenario: State 1 State 2 State 3 State 4 Probability 25% 25% 25% 25% Spot rate $1.50/€ $1.40/€ $1.30 $1.20/€ P* €1,500 €1,400 €1,300 €1,200 P $1,920 $1,660 $1,360 $1,140 In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar price of the asset. a. Compute the exchange exposure faced by the U.S. firm. b. What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against this exposure c. If the U.S. firm hedges against this exposure using a forward contract, what is the variance of the dollar value of the hedged position?

A U.S. firm holds an asset in France and faces the following scenario: State 1 State 2 State 3 State 4 Probability 25% 25% 25% 25% Spot rate $1.50/€ $1.40/€ $1.30 $1.20/€ P* €1,500 €1,400 €1,300 €1,200 P $1,920 $1,660 $1,360 $1,140 In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar price of the asset. a. Compute the exchange exposure faced by the U.S. firm. b. What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against this exposure c. If the U.S. firm hedges against this exposure using a forward contract, what is the variance of the dollar value of the hedged position?

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter8: Relationships Among Inflation, Interest Rates, And Exchange Rates

Section: Chapter Questions

Problem 31QA

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	State 1	State 2	State 3	State 4
Probability	25%	25%	25%	25%
Spot rate	$1.50/€	$1.40/€	$1.30	$1.20/€
P*	€1,500	€1,400	€1,300	€1,200
P	$1,920	$1,660	$1,360	$1,140