A U.S.firm holds an asset in Great Britain and faces the following scenario:
$\begin{array}{l}\begin{array} { l } &\text { State 1}\\\text { Probability } & 25 \% \\\text { Spotrate } & \$ 2.20 / £ \\P^{*} & £ 1,800 \\P & \$ 4,500\end{array}\begin{array} { l } \text { State 2}&\text { State 3}\\50 \% & 25 \% \\\$ 2.00/£ & \$ 1.60 / £ \\£ 2,250 & £ 2,812.50 \\\$ 4,500 & \$ 4,500\end{array}\end{array}$
where,
P^* = Pound sterling price of the asset held by the U.S.firm
P = Dollar price of the same asset
The expected value of the investment in U.S.dollars is:

Question

A U.S.firm holds an asset in Great Britain and faces the following scenario:

\begin{array}{l}\begin{array} { l } &\text { State 1}\\\text { Probability } & 25 \% \\\text { Spotrate } & \$ 2.20 / £ \\P^{*} & £ 1,800 \\P & \$ 4,500\end{array}\begin{array} { l } \text { State 2}&\text { State 3}\\50 \% & 25 \% \\\$ 2.00/£ & \$ 1.60 / £ \\£ 2,250 & £ 2,812.50 \\\$ 4,500 & \$ 4,500\end{array}\end{array}

where,
P^* = Pound sterling price of the asset held by the U.S.firm
P = Dollar price of the same asset
The expected value of the investment in U.S.dollars is:

Quizplus · Accepted Answer

We can calculate the expected value of the investment as follows:

EV = (0.25)(4500) + (0.5)(4500) + (0.25)(4500) 
   = 2250 + 2250 + 1125 
   = 5625/2 
   = 2825

However, since the asset is held in Great Britain, we need to convert the expected value to pounds sterling. Using the spot rates given in each state, we can find the pound sterling value of the expected value in each state:

EV1 = 2825/2.20 = £1284.09 
EV2 = 2825/2.00 = £1412.50 
EV3 = 2825/1.60 = £1765.63

Finally, we need to calculate the expected pound sterling value of the investment:

EPV = (0.25)(1800) + (0.5)(2250) + (0.25)(2812.50) 
    = 450 + 1125 + 703.13 
    = £2278.13

Since the expected pound sterling value of the investment (£2278.13) is greater than the pound sterling value of the expected value of the investment in any state, it is the best choice. Therefore, the answer is B.

A USfirm Holds an Asset in Great Britain and Faces the the Following