Question

All Nippon Airway which goes by ANA (9202 on the Tokyo Stock Exchange) has just signed a contract with Boeing to purchase a new 787 for a total of $120,000,000, with payment in three equal tranches. The first tranche of $40,000,000 has just been paid. The next $40,000,000 is due three months from today, and the final payment will be in nine months (270 days). ANA currently has excess cash of ¥10,500,000,000 (yen) in an Osaka bank, it is from these funds that ANA wishes to make the payments.

The current spot rate is 108.57¥/$, permission has been obtained for a forward rate (90 days), 107.52/$, and a forward rate of (270 days) 105.78¥/$. The Eurodollar interest rate for the period is 6.000%, while the yen deposit rate is 3.250%. ANA can borrow in yen at 3.500%, and can borrow in the U.S. dollar market at 8.375%.

A three month call option on dollars in the over-the-counter market, for a strike price of yen 107/$ sells at a premium of 1.18%, payable at the time the option is purchased. A 90 day put option on dollars with the same strike sells at a premium of 1.1%, options for 270 days for a strike of 106¥/$ can be obtained for a premium of 2.73% and 2.9% respectively. ANA's foreign exchange advisory service forecasts the spot rate in three months to be 107.50¥/$ and the nine month spot at 105.75 ¥/$.

How should ANA plan to make the payment to Boeing if ANA's goal is to balance the amount paid in Yen against the ending balance of their account? ANA could do nothing and rely upon the spot prices or use hedging (Forward Hedge, Money Market Hedge or Use of Options) to minimize the expenditure. Make a recommendation and defend it.

Answer 1

Assumption: 360 days in a year are assumed & the eurodollar interest rate is 6% p.a
Lets consider all the three options one by one that is Forwards, Money Market Hedge and Option.
1) Forwards
Total amount of yens that are required to be paid are as follows:	Amount in Yens
For 90 days forward:		($40000000*107.52)	4300800000
For 270 days forward:		($40000000*105.78)	4231200000
				Total:	8532000000
2) Money Market Hedge
We have foreign currency liability in $ and thus we need to create foreign currency asset in $ and therefore we will first sell the yens and purchase requisite number of $ so that we can use them to pay on 90th & 270th day. Further we will also earn 6% interest on amount deposit in $ thus by doing the reverse calculations we will calculate our answers as follows:
Total amount of yens that are required to be paid are as follows:	Amount in $
For 90 days forward:		($40000000/101.5%)	39408867.00
For 270 days forward:		($40000000/104.5%)	38277511.96
				Total:	77686378.96
Particulars					%
Interest rate for 90 days			6%/360*90*100	=	1.5
Interest rate for 270 days			6%/360*270*100	=	4.5
Thus the total amount in yens that is required to be paid now is equal to $77686378.96*108.57yens that is yens 8434410164
3) Options
Days	Strike Price	Forcasted Spot Price	Call Premium	Put Premium
90	107	107.5	1.18%	1.10%
270	106	105.75	2.73%	2.90%
Since we have to pay our obligations in $ at 90th and 270th day we will buy call option (as the exchange rate given for base currency in $) at the premiums given above for call options. Also we will buy $ at 90th day at 107 by exercising the option as the spot price forcasted is more than the current strike price and at 270th day at 105.75 by not exercising the option as the spot price forcasted is less than the current strike price.
Premium Calculations:			Amount in yens
For 90 days	$40000000*107*1.18%	=	50504000
For 270 days	$40000000*106*2.73%	=	115752000
		Total	166256000
Amount Required to purchase $ at day 90 & 270:		Amount in Yens
For 90 days	40000000*107	4280000000
For 270 days	40000000*105.75	4230000000
	Total	8510000000
Thus the total amount in yens that is required is total of premium and basic amount which is 166256000+8510000000 which totals to 8676256000 yens
Conclusion: Since after comparing all the above three options the best option is to go for money market hedge as the amount of yens required in that case are least which is 8434410164.