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Suppose a U.S. firm has an asset in Germany and faces the following scenario: State Probability P* S SxP* 1 1/4 980 $1.40/ $1,372 2
- Suppose a U.S. firm has an asset in Germany and faces the following scenario:
State | Probability | P* | S | SxP* |
1 | 1/4 | 980 | $1.40/ | $1,372 |
2 | 1/4 | 1,000 | $1.50/ | $1,500 |
3 | 1/4 | 1,070 | $1.60/ | $1,712 |
4 | 1/4 | 1,190 | $1.70/ | $2,023 |
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.
- Compute the exchange exposure faced by the U.S. firm (for each case).
- What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against this exposure?
- 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?
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