In April 2016, an FI Bought a One-Month Sterling T-Bill

question 93

Multiple Choice

In April 2016, an FI bought a one-month sterling T-bill paying £100 million in May 2016.The FI's liabilities are in dollars, and current exchange rate is $1.6401/£1.The bank can buy one-month options on sterling at an exercise price of $1.60/£1.Each contract has a size of £31,250, and the contracts currently have a premium of $0.014 per £.Alternatively, options on foreign currency futures contracts, which have a size of £62,500, are available for $0.0106 per £. What is the foreign exchange risk that the FI is facing, and what type of currency option should be purchased to hedge this risk?

• A)The FI should use put options to hedge the depreciation of the dollar.
• B)The FI should use call options to hedge the depreciation of the pound sterling.
• C)The FI should use put options to hedge the depreciation of the pound sterling.
• D)The FI should use call options to hedge the depreciation of the dollar.
• E)The FI should use put options to hedge the appreciation of the pound sterling.

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Definitions:

Market System

An economic system in which decisions regarding investment, production, and distribution are based on supply and demand, and prices of goods and services are determined in free markets.

Inefficiency

A condition where resources are not used in the most economically beneficial way, leading to wasted resources or less-than-optimal outcomes.

Communist Central Planning

An economic system where all major production decisions are made by the government, with an aim of allocating resources according to a comprehensive plan.