Question

You are an American Investor and have a project in country "C" that will provide you with a 10% return at the end of the year (assume no project risk). The current Foreign Exchange (local currency/USD) is 3.

(a) What happens with your investment returns after considering FX effects if exchange becomes 3.20? and if it becomes 2.90?
(b) What should the exchange rate be to break even? (i.e. total return =0%)
(c) your economic research team gives you the additional information: e subscript 1 = 3.05 with probability 50% e subscript 2 =2.90 with probability 30% and e subscript 3= 3 with probability 20%. What is your expected e subscript 1 based on that info?

Answer 1

The exchange rate affects the investor's returns. If the exchange rate increases, the returns increase and if the exchange rate decreases, the returns decrease. To break even, the exchange rate should be equal to the investment divided by the investment multiplied by the return. The expected exchange rate can be calculated using the probabilities given.

Step-by-step explanation:

The exchange rate is the value of one currency in terms of another currency. In this case, the American investor has a project in country C that will give them a 10% return at the end of the year. The current exchange rate is 3 local currency/USD. If the exchange rate becomes 3.20, the investor's returns will increase. For example, if the investment is $10,000, the return in country C's currency would be 32,000. If the exchange rate becomes 2.90, the investor's returns will decrease. For example, if the investment is $10,000, the return in country C's currency would be 29,000.

To break even, the total return should be 0%. To calculate this, you can use the following formula: exchange rate = investment / (investment * return). Plugging in the investment of $10,000 and the return of 10%, we get an exchange rate of 3, meaning that the exchange rate should be 3 for the investor to break even.

To calculate the expected exchange rate based on the given probabilities, we can use the following formula: expected value = probability 1 * e_1 + probability 2 * e_2 + probability 3 * e_3. Plugging in the values, we get an expected e_1 of 3.02.