An FI has assets denominated in British pounds of $125 million and pound liabilities of $100 million.

Question:

An FI has assets denominated in British pounds of $125 million and pound liabilities of $100 million. The of dollars for pounds is currently $1.60/£.
a. What is the FI's net exposure?
b. Is the FI exposed to a dollar appreciation or depreciation?
c. How can the FI use futures or forward contracts to hedge its FX rate risk?
d. If a futures contract is currently trading at $1.55/£, what is the number of futures contracts that must be utilized to fully hedge the FI's currency risk exposure? Assume the contract size on the British pound futures contract is £62,500.
e. If the British pound falls from $1.60/£ to $1.50/£, what will be the impact on the FI's cash position?
f. If the British pound futures falls from $1.55/£ to $1.45/£, what will be the impact on the FI's futures position?
g. Using the information in parts (e) and (f), what can you conclude about basis risk?
In cases where basis risk occurs, a perfect hedge is not possible.
Exchange Rate
The value of one currency for the purpose of conversion to another. Exchange Rate means on any day, for purposes of determining the Dollar Equivalent of any currency other than Dollars, the rate at which such currency may be exchanged into Dollars...