A us firm holds an asset in great britain and faces

41) 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
*
£ 3,000 £ 2,500 £ 2,000
P $ 6,600 $ 5,000 $ 3,600
where,
P
*
= Pound sterling price of the asset held by the U.S. firm
P = Dollar price of the same asset
The "exposure" (i.e. the regression coefficient beta) is
Hint: Calculate the expression .
A)7,500
B) 2,500
C) − 2,500
D) none of the options
Answer: A
Explanation: First, find the variance. The mean is 2 = ($2.2 + $2 + $1.8) / 3; [0.25 (2.2 − 2)
2
] +
[0.5 (2 − 2)
2
] + [0.25 (1.8 − 2)
2
] = 0.01 + 0 + 0.01 = 0.02 Next, find the covariance, where the
mean = $5,066.67 = ($6,600 + $5,000 + $3,600) / 3. Solve, 0.25 [($6,600 − $5,066.67) × (2.2 −
2)] + 0.5 [($5,000 − $5,066.67) × (2 − 2)] + 0.25 [($3,600 − $5,066.67) × (1.8 − 2)] = 76.6665 +
0 + 73.3335 = 150. Exposure = 150 / 0.02 = $7,500.
Topic: Operating Exposure: Definition

42) 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
*
£ 3,000 £ 2,500 £ 2,000
P $ 6,600 $ 5,000 $ 3,600
where,
P
*
= Pound sterling price of the asset held by the U.S. firm
P = Dollar price of the same asset
Which of the following conclusions are correct?
A) Most of the volatility of the dollar value of the British asset can be removed by hedging
exchange risk because b
2
[Var( S )] and VAR( e ) are 1,125,000 ($)
2
and 2,500 ($)
2
respectively.
B) Most of the volatility of the dollar value of the British asset cannot be removed by hedging
exchange risk because b
2
[Var( S )] and VAR( e ) are 236,717 ($)
2
and 493,751 ($)
2
respectively.
C) Most of the volatility of the dollar value of the British asset cannot be removed by hedging
exchange risk because b
2
[Var( S )] and VAR( e ) are 125,000 ($)
2
and − 127,500 ($)
2
respectively.
D) Most of the volatility of the dollar value of the British asset can be removed by hedging
exchange risk because b
2
[Var( S )] and VAR( e ) are 125,000 ($)
2
and − 127,500 ($)
2
respectively.
Answer: A
Topic: Operating Exposure: Definition

43) 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
*
£ 3,000 £ 2,500 £ 2,000
P $ 6,600 $ 5,000 $ 3,600
where,
P
*
= Pound sterling price of the asset held by the U.S. firm
P = Dollar price of the same asset
Which of the following would be an effective hedge?