Question: A United State firm holds an asset in France and faces the following scenario
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State 1
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State 2
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State 3
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State 4
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Probability
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25%
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25%
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25%
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25%
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Spot rate
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$1.20/€
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$1.10/€
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$1.00/€
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$0.90/€
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P*
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1500
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1400
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1300
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1200
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P
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$1,800
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$1,540
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$1,300
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$1,080
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In the above table, P* is the euro price of the asset held by the United State firm and P is the dollar price of the asset.
[A] Calculate the exchange exposure faced by the United State firm.
[B] Calculate the variance of the dollar price of this asset if the United State firm remains unhedged against this exposure?
[C] If the United State firm hedges against this exposure using the forward contract, determine the variance of the dollar value of the hedged position?