A U.S. firm holds an asset in France and faces the following scenario:
|
State 1
|
State 2
|
State 3
|
State
|
|
Probability
|
25%
|
25%
|
25%
|
25%
|
|
Spot rate
|
$1.20/€
|
$1.10/€
|
$1.00/€
|
$0.90/€
|
|
P*
|
€ 1,500
|
€ 1,400
|
€ 1,300
|
€ 1,200
|
|
P
|
$1,800
|
$1,540
|
$1,300
|
$1,080
|
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 the forward contract, what is the variance of the dollar value of the hedged position?