Hi. I just need this problem solved with a thorough explanation. Thanks. Your US based firm owns
Question:
Hi. I just need this problem solved with a thorough explanation. Thanks.
Your US based firm owns an asset in the UK. P* in tale below is the one-year forecast of the asset value in. The expected 1-yr spot rateof the in $ is also given below. The forecast considers only three states, the probability of each state is given below. In the derivatives markets, the 1-year forward price is 2$/. One of your company's interns tells you that the covariance between the exchange rate and the dollar value of the building is equal to 517.6. The variance of the exchange rate $/ is 0.0984
State 1: Probability 40%; Expected 1-yr Spot rate $2.30/; P* 3,000
State 2: Probability 20%; Expected 1-yr Spot rate $2.00/; P* 2,500
State 3: Probability 40%; Expected 1-yr Spot rate $1.60/; P* 2,000
a/ design themost effectivefinancial hedge. Be clear on method and trades.
b/ suppose that you implement your hedge, what will be your $ cash flows in each state?