Question

Momomo is a construction company in Japan. Momomo is concerned on the depreciation of Japanese Yen in the future. The company expected to pay its supplier EUR 950,000 in Germany in three months. At the same time, Momomo is expected to receive a payment of USD1,500,000 from its customer, three months from now. The cost of capital for Sakura is 7.5%.

The current spot rate is at JPY 109/USD and JPY120/EUR The following information was given by Momomo’s bank.

	Exercise Price	premium
Call option on Yen	JPY 115/USD	1.25%
Call option on Yen	JPY 126/EUR	0.95%
Put Option on Yen	JPY118/USD	1.23%
Put Option on Yen	JPY127/EUR	1.00%

a. How much is the minimum receipt that Momomo able to get if the company decides to perform option market hedge of its account receivable? State your answer in JPY

b. Calculate the maximum cost that Momomo has to bear if the company decides to hedge its account payable using option. State your answer in JPY.

Answer 1

Part a) Momomo expected to receive $1,500,000 from its customer, three months from now.

For this transaction, Momomo has to sell $ & receive JPY so enter Put option on Yen at JPY118/USD now & pay 1.23% premium now itself.

Premium payable = USD 1,500,000*spot rate*1.23% = $1,500,000*JPY109*1.23% = JPY 2,011,050

Premium paid value after 3months = Premium amount*(1+cost of capital for 3months) = JPY 2,011,050*[1+(0.075*3months/12months)] = JPY 2,011,050*(1+0.01875) = JPY 2,011,050*1.01875 = JPY2,048,757

Minimum amount receivable = Transaction value*exercise price = $1,500,000*JPY118 = JPY177,000,000

Minimum Net amount receivable = Minimum amount receivable-Premium paid value after 3months = JPY177,000,000-JPY2,048,757 = JPY 174,951,243.

Part b) Momomo expected to pay EUR 950,000 to its suppliers, three months from now. For this transaction, Momomo has to buy EUR & pay JPY so enter call option on Yen at JPY126/EUR now & pay 0.95% premium now itself.

Premium payable = EUR 950,000*spot rate*0.95% = EUR950,000*JPY120*0.95% = JPY 1,083,000

Premium paid value after 3months = Premium amount*(1+cost of capital for 3months) = JPY 1,083,000*[1+(0.075*3months/12months)] = JPY 1,083,000*(1+0.01875) = JPY 1,083,000*1.01875 = JPY1,103,306

Maximum amount payable = Transaction value*exercise price = EUR 950,000*JPY126 = JPY119,700,000

Maximum cost = Maximum amount payable+Premium paid value after 3months = JPY119,700,000+JPY1,103,306 = JPY 120,803,306.

Note: In both case premium is taken to future value, because we can add or deduct money exist at the same time only. Even without taking into future value we can tell maximum amount payable & minimum amount receivable by comparing actual premium payment.