Suppose a U.S. investor wishes to invest in a British firm currently selling for £40 per share.
The investor has $12,000 to invest, and the current exchange rate is $2/£. Consider three possible prices per share at £36, £41 and £46 after 1 year.
Also, consider three possible exchange rates at $1.6/£, $2/£ and $2.4/£ after 1 year.
Calculate the standard deviation of both the pound- and dollar-denominated rates of return if each of the nine outcomes (three possible prices per share in pounds times three possible exchange rates) is equally likely.