Question 5

A U.S. firm holds an asset in India and faces the following scenario:

	State 1	State 2	State 3
Probability	25%	50%	25%
Spot rate	$0.3/Indian Rupee	$0.20/Indian Rupee	$0.15/Indian Rupee
P*	Indian Rupee 2,000	Indian Rupee 5,000	Indian Rupee 3,000

In the above table, P^* is the Indian Rupee price of the asset held by the U.S. firm.

(a) Compute the exchange exposure faced by the U.S. firm.

(10 marks)

(b) What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against this exposure?

(10 marks)