The average duration of the loans is 10 years.The average duration of the deposits is 3 years. $$\begin{array} { | l | r | l | r | }
\hline \text { Consumer loans } & \$ 50 \text { million } & \text { Deposits } & \$ 235 \text { million } \
\hline \text { Commercial Loans } & \$ 200 \text { million } & \text { Equity } & \$ 15 \text { million } \
\hline \text { Total Assets } & \$ 250 \text { million } & \text { Total Liabilities \& Equity } & \$ 250 \text { million } \
\hline
\end{array}$$ If the current (spot) rate for one-year British pound futures is currently at $1.58/? and each contract size is ?62,500, how many contracts are required to be purchased or sold in order to fully hedge against the pound exposure? (Assume no basis risk).
A)Sell 1,600 BP futures.
B)Buy 1,600 BP futures.
C)Sell 1,712 BP futures.
D)Buy 2,560 BP futures.
E)Buy 1,712 BP futures.

Question

The average duration of the loans is 10 years.The average duration of the deposits is 3 years. $$\begin{array} { | l | r | l | r | } 
\hline \text { Consumer loans } & \$ 50 \text { million } & \text { Deposits } & \$ 235 \text { million } \
\hline \text { Commercial Loans } & \$ 200 \text { million } & \text { Equity } & \$ 15 \text { million } \
\hline \text { Total Assets } & \$ 250 \text { million } & \text { Total Liabilities \& Equity } & \$ 250 \text { million } \
\hline
\end{array}$$ If the current (spot) rate for one-year British pound futures is currently at $1.58/? and each contract size is ?62,500, how many contracts are required to be purchased or sold in order to fully hedge against the pound exposure? (Assume no basis risk).
A)Sell 1,600 BP futures.
B)Buy 1,600 BP futures.
C)Sell 1,712 BP futures.
D)Buy 2,560 BP futures.
E)Buy 1,712 BP futures.

Quizplus · Accepted Answer

To hedge against the pound exposure, we first need to calculate the total exposure in pounds. Since the total assets and liabilities are equal at $250 million, the net exposure is $250 million. To convert this into pounds, we divide by the spot rate: $250,000,000 / $1.58 = £158,227,848.10. Each futures contract covers £62,500, so the number of contracts needed is £158,227,848.10 / £62,500 = 2,531.64557, which rounds to approximately 2,532 contracts. However, none of the options exactly match this calculation, indicating a possible misunderstanding in the calculation process or the information provided. Given the options, the closest match or a plausible answer based on the provided options and assuming a direct conversion might be misunderstood, is to buy 1,712 BP futures to hedge against the exposure, assuming there's an implicit or explicit detail not accounted for in the direct calculation. This choice is based on the options available and recognizing that the exact calculation does not match any of the provided options, suggesting a need for clarification or a different interpretation of the hedge requirement.

The Average Duration of the Loans Is 10 Years If the Current (Spot) Rate for One-Year British Pound Futures