Find an effective hedge financial hedge if 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

P^* = Pound sterling price of the asset held by the U.S. firm

P = Dollar price of the same asset

The CFO runs a regression of the form P = a + b S + e The regression coefficient beta is calculated as Where Cov(P,S) = 0.25 ($6,600 $5,050) ($2.28 $2.00) + 0.50 ($5,000 $5,050) ($2.00 $2.00) + 0.25 ($3,600 $5,050) ($1.80 $2.00) Cov(P,S) = 77.50 + 0 + 72.50 Cov(P,S) = 150 The variance of the exchange rate is calculated as E(S) = 0.25 $2.20 + 0.50 $2.00 + 0.25 $1.80 = $.55 + $1 + $.45 = $2.00 VAR(S) = 0.25($2.20 $2.00)2 + 0.50($2.00 $2.00)2 + 0.25($1.80 $2.00)2 = 0.01 + 0 + 0.01 = 0.02 The expected value of the investment in U.S. dollars is: E[P] = 0.25 $6,600 + 0.50 $5,000 + 0.25 $3,600 = $5,050

Suppose that you implement your hedge from the last question at F₁($/) = $2/. Your cash flows in state 1, 2, and 3 respectively will be

Multiple Choice

• $5,100, $5,000, $5,100.

• none of the options

• $5,100, $5,100, $5,100.

• $5,000, $5,000, $5,000.