Suppose a U.S. investor wishes to invest in a British firm currently selling for

Question

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/S. Consider three possible prices per share at £35, S40, and £45 after 1 year. Also, consider three possible exchange rates at $1.80/E, $2/E, and $2.20/E after 1 year. Calculate the standard deviation of both the pound-and dollar-denominated rates of return if each of the nine outcomes (three possible prices per share in pounds times three possible exchange rates) is equally likely. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Standard deviation of pound-denominated return Standard deviation of dollar-denominated return

Explanation / Answer

Expected return in Pound:

Standard deviation of pound return:

Standard deviation of pound denominated return= 10.21%

In determining dollar denominated return 9 possibilities exist:

Expected dollar return:

Standard deviation of USD denominated return= 13.10%

Condition Probability Pound Pound Return Weighted return Investment Expected value Return Return % Boom 0.333333 -0.125 -0.04 40 35 -5 -0.125 Good 0.333333 0 0.00 40 40 0 0 Poor 0.333333 0.125 0.04 40 45 5 0.125 Expected return 0.00

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