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Question 8.P.10: LMP’s managers forecast that the time-1 spot FX rate will be...

LMP’s managers forecast that the time-1 spot FX rate will be the intrinsic spot FX rate. (a) What is TXZ’s intrinsic business value in British pounds? (b) What is TXZ’s intrinsic business value in U.S. dollars?

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(a) E^*(x^{\$/£}) = 3.5\% – 4\% + 0.30(5\%) = 1\%. Using equation (8.1), 1+{k_i}^\$=(1+{k_i}^€)(1+E^*(x^{\$/€}))+({\xi _{i€}}^\$ -1){\sigma _€}^2 given {\xi_{O£}}^\$= 1.50, TXZ’s \ {k_O}^£ \ is \ (1.10 – 0.50(0.08^2))/1.01 – 1 = 0.0859, or \ 8.59\%. TXZ’s \ {V_B}^£ = £1 \ million/1.0859 = £0.921 \ million.

(b) £0.921 million(1.60 $/£) = $1.473 million.

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