A portfolio manager owns a bond worth £ 2,000,000 that will mature in one year. The pound is currently worth $ 1.65, and the one- year future price is $ 1.61. If the value of the pound were to fall, the portfolio manager would sustain a loss. If the value of the pound were to rise, the portfolio manager would experience a profit.
(a) What is the expected payment in U.S. dollars based on the current exchange rate?
(b) What is the expected payment based on the futures exchange rate?
(c) If, after a year, the pound is worth $ 1.53, what is the loss from the decline in the value of the pound?
(d) To avoid the potential loss in Part (c) the portfolio manager hedges by selling futures contracts for the delivery of pounds at $ 1.61. If, after hedging, the price of the pound falls to $ 1.53, what is the maximum amount the portfolio manager can lose?