Question

PROBLEM 1. Suppose that you are real estate investor based in the US. You have large holdings of commercial real estate in London. The developing tensions between the European Union and the UK have raised the possibility that the two parties will not reach a trade deal by the end of the year, a key action implementing the UK's exit from the European Union. This possibility is giving you a great big headache. You are not sure what to do with your investments. Here is how it looks. You own buildings worth 400 million British Pounds in London. You have a global business, but most of your activity is in the US. Your expenses and most of your business is in US dollars, so you look at everything in terms of dollars. You are trying to figure out whether to sell the buildings or keep them. Here are some of the things you need to think about.

a. When the value of the Pound rose from about 1.248 Dollars/Pounds on June 24, 2020 to 1.289 Dollars/Pound on September 21, 2020, by how much did the value of your buildings (calculated in US dollars and in %) change?

b. You are concerned that poor management by the UK Government of COVID 19 could pull down real estate prices as the pandemic continues and the economy suffers. You are also worried that the UK Government will take a hard line in dealing with the EU, resulting in a weaker Pound. Your guess is that there is a strong chance that the Government will go ahead with a “no-deal” approach, but that there is also some chance that a compromise will be reached. Your guesses about the exact probabilities of three different outcomes are given below.

Using the expected value approach explained below, calculate what your expected rate of return on the buildings in the next year would be based on the following information: (Use the starting values that the buildings are initially worth 400 million Pounds, and the 1.289 US Dollar = 1 Pound.)

--There is a 25% chance the buildings will rise 3% in value (calculated in Pounds) and the Pound will fall 5%. (COVID well managed, no-deal Brexit)

--There is a 60% chance the buildings will fall 15% in value (calculated in Pounds) and the Pounds will fall 10% (COVID badly managed, no-deal Brexit,)

--There is a 15% chance the buildings will fall 2% in value (calculated in Pounds) and the Pounds will rise 4%. (Moderate COVID problems, deal with EU).

c. Suppose that you could either keep the buildings or sell them and invest the dollars in the bank at 2% interest. Which would be a better choice based on the information in part (b)? Explain why.

Answer 1

Ans.A. The buildings are worth GBP 400 mn

Value of $/GBP on June 24,2020 = $1.248/pound

Value of $/GBP on September 21, 2020 = $1.289/pound

So, the value of pounds appreciated in relation to $, or we can say that $ depreciated in relation to pound.

Value of property in $ on June 24,2020 = GBP 400 mn*$1.248

= $ 499.20 mn

Value of property in $ on September 21, 2020 based on that day’s $/pound rate = GBP400 mn * $1.289

= $ 515.60 mn

So, the value in $ has increased from $499.20 mn to $515.60 mn.

Change in % = (($515.6 mn - $499.2 mn)/$499.2 mn )* 100

3.29%