Suppose a U

question 78

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. 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:

Worth

The value or importance of something, often measured in terms of money or utility.

Marginal Utility

The additional satisfaction or utility received by a consumer from consuming one more unit of a good or service.

Consumer Surplus

The divergence between the sum consumers are prepared and financially capable to pay for a good or service and the sum they actually disburse.

Marginal Utility

The extra pleasure or benefit received from using an additional unit of a product or service.