In April 2012, an FI Bought a One-Month Sterling T-Bill

question 70

Multiple Choice

In April 2012, an FI bought a one-month sterling T-bill paying £100 million in May 2012. 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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