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British stock price
Investment
Exchange rate ($/L)
Solution
a. Share purchased #DIV/0!
b.
Price per
share
Pound
return
1.80 2.00 2.20
Dollar return per FX rate ($/L)
Suppose a U.S. investor wishes to invest in a British firm currently selling for
£40 per share. The investor has $10,000 to invest, and the current exchange rate
is $2/£.
a. How many shares can the investor purchase?
b. Fill in the table below for rates of return after one year in each of the nine
scenarios (three possible prices per share in pounds times three possible
exchange rates).
c. When is the dollar-denominated return equal to the pound-denominated
return?
British stock price
Investment
Exchange rate ($/L)
Solution
Share purchased #DIV/0!
Price per
share
Pound
return
1.80 2.00 2.20
Dollar return per FX rate ($/L)
If each of the nine outcomes in Problem 5 is equally likely, find the
standard deviation of both the pound- and dollar-denominated rates of
return.
British stock price
Investment
Exchange rate ($/L)
Forward contracts
Forward FX rate
Solution
Share purchased #DIV/0!
Price per
£35.00 #DIV/0! #DIV/0! #DIV/0!
Dollar return per FX rate ($/L)
Dollar return per FX rate ($/L)
Now suppose the investor in Problem 5 also sells forward £5,000 at a
forward exchange rate of $2.10/£.
a. Recalculate the dollar-denominated returns for each scenario.
b. What happens to the standard deviation of the dollar-denominated
return? Compare it to both its old value and the standard deviation of the
pound-denominated return.
Spot rate ($/L)
1 yr forward rate ($/L)
British risk free rate
If the current exchange rate is $1.75/£, the one-year forward
exchange rate is $1.85/£, and the interest rate on British government
bills is 8% per year, what risk-free dollar denominated return can be
locked in by investing in the British bills?
