Exchange rate is currently $1.85 US per 1 British pound. Interest rate is 4% in the US and 3% in the UK. A bank is long a futures contract to buy 1,000,000 pounds for $1.8 million in one year.
a. Find the expected future spot exchange rate using the interest rate parity
b. What is the current present value of the futures contract to the bank?
c. What risk is the bank facing?
d. What is the delta of the bank’s long futures position?
e. If the spot exchange rate decreases by $0.10, what is the dollar loss on the futures position?
f. In order to hedge its futures exposure, should the bank borrow in the UK or invest in the UK? How much?
g. If the bank hedges the futures contract, what is the total value of the bank’s portfolio?