Hanson Corp. frequently uses a forward hedge to hedge its British pound (£) payables. For the next quarter, Hanson has identified its net exposure to the pound as being £1,000,000. The 90-day forward rate is $1.50. Furthermore, Hanson's financial center has indicated that the possible values of the British pound at the end of next quarter are $1.57 and $1.59, with probabilities of .50 and .50, respectively. Based on this information, what is the expected real cost of hedging payables?
A) $80,000.
B) -$80,000.
C) $1,570,000.
D) $1,580,000.

Question

Quizplus · Accepted Answer

$\begin{array} { l } 
R C H ( 1 ) = ( £ 1,000,000 \times \$ 1.50 ) - ( £ 1,000,000 \times \$ 1.57 ) = - \$ 70,000 \
R C H ( 2 ) = ( £ 1,000,000 \times \$ 1.50 ) - ( £ 1,000,000 \times \$ 1.59 ) = - \$ 90,000 \
E [ R C H ] = ( .50 ) ( - 70,000 ) + ( .50 ) ( - \$ 90,000 ) = - \$ 80,000
\end{array}$