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

question 6

Multiple Choice

A U.S.firm holds an asset in Great Britain and faces the following scenario:
$\begin{array}{l}\begin{array} { l } &\text { State 1}\\\text { Probability } & 25 \% \\\text { Spotrate } & \$ 2.20 / £ \\P^{*} & £ 1,800 \\P & \$ 4,500\end{array}\begin{array} { l } \text { State 2}&\text { State 3}\\50 \% & 25 \% \\\$ 2.00/£ & \$ 1.60 / £ \\£ 2,250 & £ 2,812.50 \\\$ 4,500 & \$ 4,500\end{array}\end{array}$
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 conclusions are correct?

• A)Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b²[VAR(S)] and VAR(e)are 0 ($)² and 0 ($)² respectively.
• B)None of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b²[VAR(S)] and VAR(e)are 0 ($)² and 0 ($)² respectively.
• C)Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b²[VAR(S)] and VAR(e)are 125,000 ($)² and −127,500 ($)² respectively.
• D)Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b²[VAR(S)] and VAR(e)are 125,000 ($)² and −127,500 ($)² respectively.