Suppose a U Which of the Following Statements Is Most Correct?
A)The Firm

question 15

Multiple Choice

Suppose a U.S.firm has an asset in Britain whose local currency price is random.For simplicity,suppose there are only three states of the world and each state is equally likely to occur.The future local currency price of this British asset (P*) as well as the future exchange rate (S) will be determined,depending on the realized state of the world. $\begin{array}{cccc}\text { State } & \text { Probability } & P^{*} & S & S \times P^{*} \\1 & 1 / 3 & £ 1,000&\$ 1.40/£ & \$ 1,400\\2 & 1 / 3 & £ 1,000&\$ 1.50 /£ & \$ 1,500 \\3 & 1 / 3 & £ 1,000&\$ 1.60 /£ & \$ 1,600\end{array}$ Which of the following statements is most correct?

• A)The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate are negatively correlated.
• B)The firm faces substantial exchange rate risk since the local currency price of the asset and the exchange rate are positively correlated.
• C)The firm's exchange rate exposure can be completely hedged with derivatives written on the British pound.
• D)Since randomness is involved,no hedging is possible.

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Definitions:

Time Deposit

A bank deposit with a fixed term or period of maturity, often offering higher interest rates than regular savings accounts.

Maturity

The time at which a financial obligation is due to be paid or a financial instrument, such as a bond, reaches its final installment.

Negotiable Instruments

Negotiable instruments are financial documents that promise payment to the holder and are freely transferable, such as checks, promissory notes, and bills of exchange.

Commercial Paper

An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories, and meeting short-term liabilities.