Question

A U.S. MNC expects to receive ¥750 million from its customer one year from now. The current spot rate is ¥116/$ and the one-year forward rate is ¥109/$. The annual interest rate is 3% on ¥ and 6% on USD. The put option on ¥ at the strike price of $0.0086/¥ with 1-year expiration costs 0.012 cent/¥, while the call option on ¥ at the strike price of $0.0080/¥ with 1-year expiration costs 0.009 cent/¥.

1. Construct forward hedging for the MNC. Evaluate the result of forward hedging.
2. Implement money market hedging (MMH) for the MNC. Evaluate the result of MMH.
3. Implement option hedging for the MNC. Conduct cash flow analysis to show the result of option
4. At what future spot rate would the MNC be indifferent between forward hedging and Money market hedging? Explain
5. At what future spot rate would the MNC be indifferent between option hedging and Money market hedging? At what future spot rate would the MNC prefer Money market hedging?
6. At what forward rate would the MNC be indifferent between forward hedging and Money market hedging? At what forward rate would the MNC prefer forward hedging?
7. How to hedge the receivable of ¥750 million if it is conditional on the acceptance of the bid.

Please show all work, thanks

Answer 1

Construct forward hedging for the MNC. Evaluate the result of forward hedging.

SELL 750 million Yen (¥ 750,000,000 ) at forward rate ¥ 109 /US dollar

Amount received after one year=(750/109) Million US dollar=6.880734 million US dollar=$6,880,734

Amount to be received at current spot rate =(750/116)million US dollar=6.465517 million USD=$6,465,517

Amount of gain =$6880734-$6,465,517 =$415,217

Implement money market hedging (MMH) for the MNC. Evaluate the result of MMH.

Borrow Present Value of 750 million Yen(¥ 750,000,000)=(750/1.03)million Yen = ¥ 728,155,340

Convert Yen to US dollar at current rate (¥ 116/USD)

Amount of US dollars Received=728155340/116=$6,277,201

Invest $6,277,201 in US at 6%

Amount to be received at end of year=Future Value =$6,277,201*1.06=$6,653,833

Amount of Gain =$6,653,833-$6,465,517 =$188,316

The amount borrowed in Yen is returned with interest when the $750 million Yen is received at the end of the year.

Implement option hedging for the MNC. Conduct cash flow analysis to show the result of option

BUY PUT option at Strike Price $0.0086/¥ at a cost of 0.009 Cents/¥

Buy 750 million options

Total cost of buying options =750million*0.009 cents=(750million*0.009)/100 US dollars=$67,500

$0.0086/¥ means for 1$=1/0.0086 Yen=116.27907 Yen

If the exchange rate falls below $0.0086/¥ at expiration, there will be loss in conversion , but there will be same amount of gain through Put Option.

Assume rate at expiration =$0.0081/¥

Amount received by converting 750 million Yen to US dollars=750 million*0.0081=$6,075,000

Payoff from Put Option =$(0.0086-0.0081)*750million=$375,000

Net Cash Inflow=$6,075,000+$375,000-$67,500=$6,382,500

At what future spot rate would the MNC be indifferent between option hedging and Money market hedging

Current Spot rate : ¥ 116/USD

The annual interest rate is 3% on ¥ and 6% on USD.

Future value of ¥ 116=116*1.03=¥ 119.48

Future Value of 1$=1*1.06=$1.06

The indifferent future spot rate : ¥119.48=$1.06

¥ (119.48/1.06)/USD

¥ 112.72/USD