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A U.S. firm holds an asset in France and faces the following scenario:

State 1 State 2 State 3 State 4

Probability 25% 30% 30% 15%

Spot rate $1.20/€ $1.10/€ $1.00/€ $0.90/€

P* €1,500 €1,400 €1,300 €1,200

P $1,800 $1,540 $1,300 $1,080

In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar price of the same asset.

(a) What is the expected value of the investment in U.S. dollars?

(b) What is the variance of the exchange rate?

(c) What is the "exposure coefficient" (i.e. the regression coefficient beta)?

(d) What is the volatility of the dollar value of the French asset?

(e) If the U.S. firm hedges against this exposure using the forward contract, what is the variance of the dollar value of the hedged position?

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