Question

Suppose that the U.S. firm Halliburton buys construction equipment from the Japanese firm Komatsu, at a price of 200,000 yen. The equipment is to be delivered to the US and paid for (in yen) in one year. The current exchange rate is 100 yen=$1. The current interest rate on one-year U.S. Treasury bills is 6%, and the interest rate on one-year Japanese government bonds is 4%.

a)If Halliburton exchanges dollars for yen today and invests in the Japancese government bonds for one year, how many dollars does it need to exchange today in order to have 200,000 yen in one year to fullfill the payment for the equipment?

b) Suppose that instead of investing in Japanese government bonds as in(a), Halliburton invests dollars in U.S. Treasury bills for one year. At the same time, it enteres a forward contract, agreeing to buy 200,000 yen in one year at an exchange rate of 98 yen = $1. How many dollars does it need to invest today?

C) Do methods in (a)-(b)expose Halliburton to exchange-rate risk?

Answer 1

a) Let's first check how many yen does it need to invest today to get 200,000 yen in one year's time

Since it will earn 4% return on these, it needs to invest 200,000/(1+4%) = 192,307.69 yen today and invest in Japanese govt bonds at 4% to get 200,000 yen one year later

Now to buy this amount of yen today, it needs to pay USD 192,307.69/100 = USD 1,923.08 today

b) First determine how many dollars are required one year later at teh forward rate of 98 yen / usd

It will be 200,000/98 = 2040.82 is teh amoutn of USD it needs to have one year later to buy 200,000 jpy at the forward rate of 98 it has booked today

To have this amount of usd one year later it needs to invest the following amoutn @6% today

2040.84/1.06 = 1925.30 usd needs to be invested today in US treasury bills so that it will become usd 2040.82 which can be used to buy jpy 200,000 one year later

c) no, neither of these methods exposes teh company to exchange rate risk. In method one, it already buys the JPY and invests it in riskfree securities, and in method two even if it doesn't buy the JPY today, it already has a forward contract that secures its rate of exchange one year later