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ABC Inc., is a US corporation.  One year from today, the company must pay its Japanese supplier...

ABC Inc., is a US corporation.  One year from today, the company must pay its Japanese supplier ¥750 million. The current spot rate is ¥/$ 116 and the 1-year forward rate is ¥/$ 109. In addition interest rates are 3 percent and 6 percent per year in Japan and the U.S., respectively. A call option on yen that expires one year from today is available.  It has an exercise price of $0.0086 per yen and costs 0.012 cent per yen. The future dollar cost (i.e the dollar cost – one year from today) of hedging this payable via a money market hedge is

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Answer #1

Amount of ¥ to deposit = present value of ¥ payable amount, discounted at the Japan interest rate for 1 year

Amount of ¥ to deposit = ¥750,000,000 / (1 + 3%)1 = ¥728,155,339.81

To deposit ¥728,155,339.81 today, $ must be converted into ¥ at the current spot rate. $ borrowed =  ¥728,155,339.81 / 116 = $6,277,201.21

Amount of $ to pay after 1 year = $ borrowed today * (1 + US interest rate)

Amount of $ to pay after 1 year = $6,277,201.21 * (1 + 6%)

Amount of $ to pay after 1 year = $6,653,833.28

future dollar cost of hedging this payable via a money market hedge is  $6,653,833.28

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