IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ¥250 million payable...

IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ¥250 million payable in 1 year. Currently, the spot exchange rate is ¥105/$ and the 1 year forward rate is ¥100/$. The 1 year money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Japan. The management of IBM are considering using a forward contract or a money market hedge to deal with this yen account payable.

a. What type of exposure does IBM face?

b. What should IBM use: a forward buy or sell, and of which currency? Why?

c. Briefly explain the process of a money market hedge and calculate the dollar cost of meeting the yen obligation at maturity via a money market hedge.

d. Which hedging alternative would you recommend? Why?

e. What type of foreign currency option could be used to hedge this exposure?

Solutions

Expert Solution

a. IBM faces a transaction ( short-run) exposure.

b.IBM has Yen payable, hence IBM needs to buy Yen and sell dollar for settlement of its Yen obligation.Hence IBM should forward sell dollar or in other words forward buy Yen.

c.for entering money market hedge, IBM should invest in Yen the present value of Yen payable, and the investment should be made by selling dollar at todays spot rate, the amount of dollar required will be borrowed and repaid after 1 year.

amount payable = Yen 250 million in 1 year

Present value of payment = amount payable/(1+ yen interest rate) =250 million/(1+0.07) =250/1.07 million =Yen 233.64486 million

amount required in dollars to invest the above amount in Yen = amount of yen rerquired/ exchange rate = Yen 233.64486 million / 105 yen/ $ =$ 2.2251891 million

above amount will be borrowed in US for 1 year at 8% p.a.

amount payable after 1 year = loan* (1+ interest rate) = $ 2.2251891(1+0.08) million =$2.4032 million

d.Outflow via money market hedge =$ 2.4032 million (as in c).

Outflow via forward contract = Amount payable/ forward rate = Yen 250 million/ 100 Yen/$ = $2.5 million

Hence hedging should be done via money market hedge as outflow is lower.

e.To hedge the exposure, buy call option on Yen or buy Put option on dollar.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

Suppose IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ¥250 million...

Suppose IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ¥250 million payable in one year. The current spot rate is 99 yen per dollar and the one-year forward rate is 95 yen per dollar. The annual interest rate is 5% in Japan and 8% in the U.S. IBM can also buy a one-year call option on yen at the strike price of $0.01 per yen for a premium of .014 cents per yen. 1.Explain how...

Ford purchased electric motors from Nidec (Japanese company) and was billed ¥200 million payable in three...

Ford purchased electric motors from Nidec (Japanese company) and was billed ¥200 million payable in three months. Two companies agree to share the currency risks. In the Price Adjustment Clause, the neutral zone is ¥115.38/$ - ¥129.42/$, the base rate is ¥122.4/$ and both parties will share the currency risk beyond a neutral zone. How much each party have to pay/receive if the exchange rate is ¥111.42/$ a. Ford pays ¥200 million; Nidec receives $1.634 million. b. Ford pays $1.634...

Dell Corp. sold a computer system to a customer in the UK and billed £10 million...

Dell Corp. sold a computer system to a customer in the UK and billed £10 million receivable in 6 months. Dell would like to control for the exchange rate risk. The current spot exchange rate is $1.30/£ and the 6-month forward exchange rate is $1.27/£ at the moment. Dell can buy a 6-month put option on £10 million with a strike price of $1.32/£ for a premium of $0.02 per pound. It can also buy a 6-month call option on...

Airbus sold an aircraft, A400, to Delta Airlines, a U.S. company, and billed $30 million payable...

Airbus sold an aircraft, A400, to Delta Airlines, a U.S. company, and billed $30 million payable in six months. Airbus is concerned with the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and six-month forward exchange rate is $1.10/€ at the moment. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six-month interest...

Suppose Boeing Corporation exported a Boeing 787 to British Airway and billed £20 million payable in...

Suppose Boeing Corporation exported a Boeing 787 to British Airway and billed £20 million payable in one year (i.e., Boeing has a £20 million receivable in one-year). The money market rates, foreign exchange rates, and option prices are given as follows: The U.S. one-year interest rate: 2% per annum The U.K. one-year interest rate: 3.5% per annum The spot exchange rate: $1.32/£ One-year forward rate: $1.2985/£ Call option: exercise rate: $1.31, premium: $0.015/£ Put option: exercise rate: $1.31, premium: $0.02/£...

Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million payable...

Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million payable in six months. Airbus is concerned about the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and the six-month forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six-month interest rate is...

A manufacturer has a fixed cost of $120 million to produce x million of computer chips...

A manufacturer has a fixed cost of $120 million to produce x million of computer chips and estimates its variable cost as $160 for x million compute chips. The manufacturer sells each chip for 165% more than its average cost per chip. a. What is the manufacturer's average cost per x million computer chip? b. What is the manufacturer's price x million computer chips? c. What is the manufacturer's break-even quantity?

Ralph's Electronics purchased 75 sound bars from the manufacturer for $250 each less discounts of 25%...

Ralph's Electronics purchased 75 sound bars from the manufacturer for $250 each less discounts of 25% and 12%. The regular markup on the sound bar is 60% of the regular selling price, and Ralph's Electronics overhead is 10% of the regular selling price. On the Black Friday sale, the sales price was reduced to $199. The regular selling price =? Profit or loss (please indicate which one) on each sound bar at the sale price = ?

An electronics company produces transistors, resistors, and computer chips. Each transistor requires 3 units of copper,...

An electronics company produces transistors, resistors, and computer chips. Each transistor requires 3 units of copper, 1 unit of zinc, and 2 units of glass. Each resistor requires 3, 2, and 1 units of the three materials, and each computer chip requires 2, 1, and 2 units of these materials, respectively. How many of each product can be made with 3045 units of copper, 1430 units of zinc, and 1915 units of glass? Solve this exercise by using the inverse...

Princess Cruise Company (PCC) purchased a ship from Mitsubishi Heavy Industry for 500 million yen payable...

Princess Cruise Company (PCC) purchased a ship from Mitsubishi Heavy Industry for 500 million yen payable in one year. The current spot rate is ¥124/$ and the one-year forward rate is 110¥/$. The annual interest rate is in Japan is 5% for lending and 6% for borrowing; and in the United States it is 7% for lending and 8% for borrowing. The WACC is 7%. PCC can also buy a one-year call option on yen at the strike price of...

Subjects