Question

A Japanese EXPORTER has a €1,000,000 receivable due in one year. Spot and forward exchange rate...

A Japanese EXPORTER has a €1,000,000 receivable due in one year. Spot and forward exchange rate data is given in the table:

 Spot Rate 1-year forward rate Contract Size \$1.20 =€1.00 \$1.25= €1.00 €62.500 \$1.00 =¥100 \$1.20= €120 ¥12,500,000

The one-year risk free rates are i\$ = 4.03%; i = 6.05%; and i¥ = 1%. Detail a strategy using forward contract that will hedge exchange rate risk.

Sell €1m forward using 16 contracts at the forward rate of \$1.25 per €1.

Borrow €970,873.79 today; in one year you owe €1m, which will be financed with the receivable. Convert €970,873.79 to dollars at spot, receive \$1,165,048.54. Convert dollars to yen at spot, receive ¥116,504,854.

Buy €1m forward using 16 contracts at the forward rate of \$1.20 per €1.

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