Question

Suppose you are a British venture capitalist holding a major stake in an e- commerce start-up in Silicon Valley. As a British resident, you are concerned with the pound value of your U.S. equity position. As an economist, you estimate 3 scenarios for the future, as described in the table below: Scenario Probability Forecast exchange rate (£/$) Forecast asset value (in $) 1 0.2 0.7485 $1,000,000 0.4 0.7470 $700,000 N 3 0.4 0.7451 $500,000 (a) Estimate your exposure to the exchange risk.[6 MARKS] (b) How would you hedge this exposure? Suppose the forward rate is 0.7460 £/$. Calculate the GBP value of the hedged portfolio under each of the scenarios above [4 MARKS] IN YOUR CALCULATION, KEEP 4 DECIMAL POINTS FOR THE EXCHANGE RATES, AND NO DECIMAL POINTS FOR CURRENCY NUMBERS

Answer 1

Prob = 0.70

P*= $1,000,000

S = $1.40

P = £714,300

Prob = 0.50

P*= $500,000

S = $1.60

P = £312,500

E(S) = (0.50)/(1.40) + (0.50)/(1.60)

= £0.6696/$

E(P)

= (0.50)*(714,300) + (0.50)*(312,500)

= £513,400/$

Var(S) = 0.00167

Cov(P,S) = 7,535

b = Cov(P,S)/Var(S) = 7,535/0.00167 = 4,511,976 ($)

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