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

question 62

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 would be an effective hedge?

• A)Sell £2,278.13 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:

Competitive Price-Searcher

A market structure where firms have some control over the price because their products are differentiated, and consumers search for the best prices among competitors.

Long-Run Economic Profit

The excess revenue over costs, including opportunity costs and explicit costs, that a firm realizes when all inputs are considered variable, typically assumed in a period where firms can enter or exit the industry.

Potential Rivals

Companies or entities not currently in the market but possess the capability to enter and compete effectively.

Monopoly

A market structure characterized by a single seller, selling a unique product in the market.