uppose you are a British venture capitalist holding a major stake in an e-commerce start-up in Silicon Valley. As a British resident, you are concerned with the pound value of your U.S. equity position. Assume that if the American economy booms in the future, your equity stake will be worth $1,000,000, and the exchange rate will be $1.58 per pound. If the American economy experiences a recession, on the other hand, your American equity stake will be worth $500,000, and the exchange rate will be $1.78 per pound. You assess that the American economy will experience a boom with a 70 percent probability and a recession with a 30 percent probability. Required: a. Estimate your exposure to the exchange risk. b. Compute the variance of the pound value of your American equity position that is attributable to the exchange rate uncertainty. c-1. How would you hedge this exposure? c-2. If you hedge, what is the variance of the pound value of the hedged position?
Suppose you are a British venture capitalist holding a major stake in an e-commerce start-up in Silicon Valley. As a British resident, you are concerned with the pound value of your U.S. equity position. Assume that if the American economy booms in the future, your equity stake will be worth $1,000,000, and the exchange rate will be $1.58 per pound. If the American economy experiences a recession, on the other hand, your American equity stake will be worth $500,000, and the exchange rate will be $1.78 per pound. You assess that the American economy will experience a boom with a 70 percent probability and a recession with a 30 percent probability.
Required:
a. Estimate your exposure to the exchange risk.
b. Compute the variance of the pound value of your American equity position that is attributable to the exchange rate uncertainty.
c-1. How would you hedge this exposure?
c-2. If you hedge, what is the variance of the pound value of the hedged position?
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