Suppose a U Assume That You Choose to "Hedge" This Asset by Selling

question 88

Multiple Choice

Suppose a U.S.firm has an asset in Italy 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 asset (P*) as well as the future exchange rate (S) will be determined,depending on the realized state of the world. $$\begin{array} { | c c l l l | } \hline \text { State } & \text { Probability } & P ^ { * } & S & S \times P ^ { * } \\\hline \mathbf { 1 } & 1 / 3 & € 1,000 & \$ 1.40 / € & \$ 1,400 \\\hline \mathbf { 2 } & 1 / 3 & € 933 & \$ 1.50 / € & \$ 1,400 \\\hline \mathbf { 3 } & 1 / 3 & € 875 & \$ 1.60 / € & \$ 1,400 \\\hline\end{array}$$ Assume that you choose to "hedge" this asset by selling forward the expected value of the euro denominated cash flow at F₁($/ $\le$ ) = $1.50/€.Calculate your cash flows in each of the possible states.

• A)$1,400, $1,400, $1,400,
• B)$1,496.6, $1,400, $1,306.40
• C)$1,404, $1,404.$1,404.
• D)None of the above

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