Question

Suppose that you hold a piece of land in the City of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that, if the British economy booms in the future, the land will be worth £2,743 and one British pound will be worth $1.36. If the British economy slows down, on the other hand, the land will be worth less, i.e., £1,880, but the pound will be stronger, i.e., $1.61/£. You feel that the British economy will experience a boom with a 60% probability and a slow-down with a 40% probability.

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

Answer 1

Pgo Answoro a convert the price into dollars 2,743x $1.36 = $3,730.48 => 1,880x$1.61 = $3,026.8 Espected price ECP)=0.6* 3,730.48+0.4*3026.8=$3,449.008 E(S) =0.6*$1.36 +0.4*1.61 = 1.46 Veriance = (0.6)(+46–136)+(0.4)(7.46-1-61)= 0.015 Covariance, COUCAS) 50.6(3,430.48 – 3,449.008) (136-1-46) +0.4 (3,086.8–3,449.008)(1.61–1:46) =-42.22 b-colpes)worcs) -43-29/0.015 =-2,814.67R -2,814.7R increases since the Exposure is negative, as the pound value against dollar, value of the british halding decreases