A U.S.-based insurance company owns a £3,200,000 corporate bond and has of £2,800,000 of claims reserves. It has also bought £750,000 and sold £675,000. The current exchange rate is $1.42/£.

 

a. Calculate the bank's dollar net exposure to pounds. Note that your answer should be in U.S. dollars.

 

b. If the dollar-per-pound exchange rate depreciates by 4%, what is the bank's dollar expected gain or loss?

 

c. What position in a forward contract based on pounds could the insurance company take to hedge its foreign exchange rate risk? Be sure to explain how this position will hedge the insurance company's risk in your response.