You own a piece of land in the city of Munich that you may want to sell in one y
ID: 2760950 • Letter: Y
Question
You own a piece of land in the city of Munich that you may want to sell in one year. As a Norwegian resident, you are concerned with the NOK value of the land. Assume that, if the German economy booms in the future, the land will be worth €2 000 and one euro will be worth NOK8.40. If the German economy slows down, on the other hand, the land will be worth less, i.e., €1 500, but the euro will be stronger at NOK8.00. You feel that the German economy will experience a boom with a 60% probability and a slow-down with a 40% probability. You decide to hedge your euro exposure by using forward contracts.
What should you do to minimize the exchange rate risk?
Buy € 5 500 forward.
Sell € 5 500 forward.
Buy € 1 800 forward.
Sell € 1 800 forward.
1.Buy € 5 500 forward.
2.Sell € 5 500 forward.
3.Buy € 1 800 forward.
4.Sell € 1 800 forward.
Explanation / Answer
Economy Condition Probability Land value Euro Expected Value Boom 60% 2,000.0 1,200.0 Slow down 40% 1,500.0 600.0 Expected Land Value 1,800.0 As the expected receipt of Land procedds will be Euro = 1,800.0 So I should sell a forward of Euro 1800 at a predermined NOK rate to hedge the transaction
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