Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U. S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability.
a. Estimate your exposure b to the exchange risk.
b. Compute the variance of the dollar value of your property that is attributable to the exvhange rate uncertainty.