A U.S firm owns a piece of land in Israel. The price (in unit of million) of the

Question

A U.S firm owns a piece of land in Israel. The price (in unit of million) of the land is expected to be:

State of Economy

Probability

Exchange Rate

PIS

PIS

State 1

25%

$0.30/IS

IS 2,000

$600

State 2

50%

$0.20/IS

IS 5,000

$1,000

State 3

25%

$0.15/IS

IS 3,000

$450

Note: PIS is the Israeli shekel (IS) price of the land.

Questions: 5 questions in total

(1)Calculate the U.S firm’s asset exposure.

(2)How to hedge its asset exposure in the forward market?

(3)Can forward hedging completely eliminate the firm’s asset exposure? Explain.

(4)How much of the dollar value variability is attributable to exchange rate uncertainty?

(5)Assume the Israeli shekel (IS) price of the land stays at IS, 3000, Can forward hedging completely eliminate the firm’s asset exposure in this case? Explain.

State of Economy

Probability

Exchange Rate

PIS

PIS

State 1

25%

$0.30/IS

IS 2,000

$600

State 2

50%

$0.20/IS

IS 5,000

$1,000

State 3

25%

$0.15/IS

IS 3,000

$450

Explanation / Answer

The exposure of US Firm is as follows.

Ans 1. The most Probalistic Invesment exposure is 1712.5 million US$.

Ans 2. The most probalistic situaltion is to remain exchange raio that one IS equal to 5 US$. hoever the PIS is likely to hard by a probanilty by 25%. therefore the PIS can be hedged from the Bankers etc at a nominal chargs.

Ans 3. No there are manifold risk , the currency can be hedged , howver if the land price fall the resale value after legal expensed will be much less and firms exposure will remain. it canot be fully / completely eliminated. exonomy and political state of affairs of Israil is voltile for reason of war etc with neighboring country thogh it is friendful relation with USA.

Ans4. the 25 % of the asset exposure i.e approcx US $ 412.13 million.

And 5. if IS price stays at mid amount i.e between Is 200 to IS 5000 , the carry forward hedging almost hedge the risk howver the there is probabilty to go down to IS 2000 i.e loss of market price by IS 1000 is in risk . The equivalent amount in US$ must be hedged to eliminate the land price risk. in addition to the exchange fluctuation risk also to be hedged for invested amount as stated under item no.1. both hedging do well and hedge the total risk of investment.

THE END

Economy state amount id USD in million Multiplier x amount amount state 1 600 600x0.25 150 state 2 1000 1000 X 0.50 500 state 3 450 450 x0.25 112.50 total 1712.50

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