Question

As an importer of grain into Japan from the United States, you have agreed to pay $377,287 in 90 days after you receive your grain. You face the following exchange rates and interest rates: spot rate, ¥106.35/$, 90-day forward rate ¥106.02/$, 90-day USD interest rate, 3.25% p.a., 90-day JPY interest rate, 1.9375% p.a. First, you could hedge your risk by buying dollars forward at ¥106.02/$. Second, you could determine the present value of the dollars that you owe and buy that amount of dollars today in the spot market. You could borrow that amount of yen to avoid having to pay today. Based on the two alternatives, how much can you save between the two alternatives? A) ¥39,999,967.74 B) ¥6092.53 C) ¥198,879.05 D) ¥124,504.71 E) None of the above

Answer 1

Answer:

B)  ¥6092.53

Explanation:

We can hedge the risk by buying dollars forward contract at a price of ¥106.02/$ which is 90 days forward rate because the payment is due in 90 days. The total contract would amount to ¥106.02/$ * $377,287 = ¥39,999,967.74

The second alternative is to buy dollar at todays date. The present value of the dollars will be ;

$377,287 / 1.008125 = $374,246.25  

If we buy dollars at spot rate then,

¥106.35/$ × $374,246.25 = ¥39,801,088.69

The future value of yen will be :

¥39,801,088.69 × (1.00484375) = ¥39,993,875.2

The difference between the two alternatives will be :

¥39,999,967.74 -  ¥39,993,875.2 =  ¥6092.53