Suppose that you hold a piece of land in the Bulgarian city of Strandzha, not far from the Turkish border, that you may want to sell in one year. As a Turkish resident, you are concerned with the Turkish lira value of the land. Assume that if the Bulgarian economy booms in the future, the land will be worth 175,000 BGN, and one Bulgarian leva will be worth 2,85TRY. If the Bulgarian economy slows down, on the other hand, the land will be worth less, 150,000BGN, but the leva will be stronger, say, 3,05TRY/BGN. You feel that the Bulgarian economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability.

a. Estimate your exposure (b) to the exchange risk.

b. How would you hedge this exposure?

c. Compute the variance of the TL value of your property that is attributable to exchange rate uncertainty.