3. Currency Risk in Foreign Equity (intermediate). During the first quarter of 2012, the Brazilian real depreciated from BRL 1.65 to BRL 1.85 = US$1. Shares of Petrobras trading on the New York Stock Exchange in the form of American depositary receipts (ADRs) declined from US$31 to US$26 over the same period.

a. How much did Petrobras shares lose in US$ terms and in BRL terms?

b. Since Petrobras ADRs are traded in the United States in US$, are they exposed to exchange rate risk – the risk that the BRL will depreciate against the US$?

c. Explain how you could hedge the US$ price of Petrobras shares against exchange rate risk.

d. If BRL can be sold or purchased forward at a 6 percent discount against the US$ for delivery on December 31, 2012, under what exchange rate scenario would you hedge your investment in shares of Petrobras? What would be the value of your hedged investment if you expect that shares of Petrobras will appreciate by 10 percent by the end of 2012? What additional information do you wish to have access to so as to make a better-informed recommendation?