An FI has assets denominated in British pounds of $125 million and pound liabilities of $100 million. The exchange rate of pounds for dollars is currently

$1.20/£.

a. What is the FI’s net FX 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 $1.15/£, 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 exchange rate falls from $1.20/£ to $1.10/£, what will be the impact on the FI’s cash position?

f. If the British pound futures exchange rate falls from $1.15/£ to $1.05/£, 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?