Ee 162. 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 areconcerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, andone British pound will be worth $3.10. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, butthe pound will be stronger, say, $3.20/£. You feel that the British economy will experience a boom with a 60 percent probability and aslowdown with a 40 percent probability.a. Estimate your exposure (b) to the exchange risk. (Negative amount should be indicated by a minus sign.)Exposureb. Compute the variance of the dollar value of your property that is attributable to exchange rate uncertainty.Variance

Exchange risk is the risk that arises due to fluctuations in the exchange rates between currencies.

Answered: Suppose that you hold a piece of land…

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter14: Multinational Capital Budgeting

Section: Chapter Questions

Problem 3ST

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JC.. 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, we are concerned with the dollar value of the land. Assume that, if the British economy booms in the future, the land will be worth £4,600 and one British pound will be worth $1.54. If the British economy slows down, on the other hand, the land will be worth more, i.e., £5,700, but the pound will be weaker, i.e., $1.32/£. You feel that the British economy will experience a boom with a 55% probability and a slow-down with a 45% probability. Given the above facts, please estimate your exposure b to the exchange risk. £47,916.00 £2,000.00 £7,282.00 £5,235.00 Same facts as above: compute the variance of the dollar value of your property that is attributable to the exchange rate uncertainty (that is, please compute the value of B2Var(S). $7,282.00 $2,000.00 $14,441.00 $47,916.00
If the U.S. economy experiences growth in the future, the property will be worth $50,000,000 and the exchange course of 1 dollar will be 0.83 euro. If the U.S. economy slows down, the property will be worth $40,000,000, but the U.S. dollar will be stronger and worth 0.89 euro. The probability of the U.S. economy to experience growth is 40% while a slow-down will happen with a 60% probability. Estimate your exposure b to the exchange risk. Compute the variance of the dollar value of your property that is attributable to the exchange rate uncertainty. Discuss which strategies you could suggest to your client to manage economic exposure.
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Suppose that you are a U.S.-based importer of goods from the United Kingdom. You expect the value of the pound to increase against the U.S. dollar over the next 60 days. You will be making payment on a shipment of imported goods in 60 days and want to hedge your currency exposure. The U.S. risk-free rate is 4.2 percent, and the U.K. risk-free rate is 1 percent. These rates are expected to remain unchanged over the next 2 months. The current spot rate is $1.3084. Calculate the no-arbitrage price at which you could enter into a forward contract that expires in 60 days. (X.XXXX)

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