Question 1

Suppose that a U.S. FI has the following assets and liabilities:

Assets

$10 million cash (in dollars)

$100 million U.S. loans (one year) (in dollars) (12%)

$100 million equivalent UK loans (one year) (loans made in pounds) (10%)

Liabilities

$200 million U.S. CDs (one year) (in dollars) (5%)

$10 million borrowed funds (in dollars) (6%)

The current spot exchange rate is $1.5/

Required:

a. What is the FI's net exposure in pounds?

b. Is this bank exposed to U.K. pound appreciation or depreciation?

c.If this FI hedges this foreign exchange risk using forward contract, what forward transaction does it need to engage (e.g., sell or buy pounds, forward period, and forward amount)?

d. If the spot foreign exchange rate falls to $1.55/1 over the year, calculate

d1.the dollar proceeds from the UK loan at the end of the year

d2.the return on the UK loan

d3.the return on the loan portfolio

d4.the net interest income for the FI at the end of year

e. If a borrower exercises $10 million of a loan commitment, present the balance sheet of this FI if this FI meets the demand by using:

e1.Stored liquidity

e2.Purchased liquidity