Why bank of maryland is concerned about potential losses

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Reference no: EM1346382

Suppose that Bank of Maryland (a U.S. bank) needs to pay its debt of €62,500 to Bank of Berlin (a German bank) in 60 days. Bank of Maryland is concerned about the potential for losses as it has been advised that the spot rate in 60 days can vary between $1.11/€1 and $1.20/€1.

In order to offset any potential losses when paying its debt in euros (€), Bank of Maryland isconsidering the use of euros (€) futures to hedge its exposure. The current 60 days futures rate is $1.15/€1.

Bank of Maryland, at the suggestion of its risk manager, is also considering the use of currency options to hedge its exchange rate risk exposure. The option has a premium of $0.02 per euro and an exercise price of $1.14/€1 at the end of 60 days. Bank of Maryland believes that the most likely price of the euro in 60 days will be $1.16/€1.

Answer the following questions:

a) Is Bank of Maryland exposed to an appreciation or depreciation of euro?

b) Should Bank of Maryland buy or sell € futures if it wants to hedge its exchange rate exposure? Explain why.

Reference no: EM1346382

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