Question

John Carrol is a U.S.-based forest products firm. In June John Carrol delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm’s foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. John Carrol has received a 180 day forward quote of ¥108/$. It also collects the following information: John Carrol’s cost of capital is 7% per annum; the Japanese money market borrowing rate is 2.5% per annum; the Japanese money market lending rate is 2.25% per annum; the U.S. money market borrowing rate is 4% per annum; the U.S. money market lending rate is 3.5% per annum.

Please analyze the forward market and money market hedge strategies step by step. Based on your quantitative analysis, which hedge strategy will you recommend? If the company locks in the forward quote and the exchange rate goes to ¥115 as expected, how much will John Carrol receive in US dollars in 180 days? (15 points)

Answer 1

forward market hedge:-

amount receivable in dollars = 55,000,000/108 = $509,259.26

money market hedge:-

borrow from japan at the rate of 2.5% = 55000000/1.025 = 53658536.59

convert into the dollars = 53658536.59/110 =$487804.87

invest that amount in to USA for the 180 days = $487804.87*1.035 = $504,878.05

based on the above results forward hedge should be taken.

if exchange rate in future is ¥115 but if wee would have taken the forward contract the value of the dollar in the future does not affect us the amount recievable will as same as in forward hedge = $509,259.26