A USfirm Holds an Asset in Great Britain and Faces the the Following

question 90

Multiple Choice

A U.S.firm holds an asset in Great Britain and faces the following scenario:
$\begin{array}{l}\begin{array} { l } &\text { State 1}\\\text { Probability } & 25 \% \\\text { Spotrate } & \$ 2.20 / £ \\P^{*} & £ 2,000 \\P & \$ 4,400\end{array}\begin{array} { l } \text { State 2}&\text { State 3}\\50 \% & 25 \% \\\$ 2.00/£ & \$ 1.80 / £ \\£ 2,500 & £ 3,000 \\\$ 5,000 & \$ 5,400\end{array}\end{array}$
where,
P^* = Pound sterling price of the asset held by the U.S.firm
P = Dollar price of the same asset
Which of the following would be an effective hedge?

• A)Sell £2,500 forward at the 1-year forward rate,F₁($/£),that prevails at time zero.
• B)Buy £2,500 forward at the 1-year forward rate,F₁($/£),that prevails at time zero.
• C)Sell £25,000 forward at the 1-year forward rate,F₁($/£),that prevails at time zero.
• D)none of the options

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Definitions:

Generous Compensation

A form of payment or reward given, typically above the average or expected amount, acknowledging someone's work or contribution.

Takeover

The acquisition of one company by another, either through a friendly acquisition or hostile bid.

Greenmail

A strategy where a company buys back its own shares from a hostile party at a premium to avoid a takeover.

Targeted Stock Repurchase

A tactic used by corporations to buy back shares from specific shareholders, often to avert a takeover bid or reduce share dilution.