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Krystal.Krystal is a U.S.-based company that manufactures, sells, and installs water purification equipment. On April 11, the company sold a system to the City of Nagasaki, Japan, for installation in Nagasaki's famous Glover Gardens (where Puccini's Madame Butterfly waited for the return of Lt. Pinkerton). The sale was priced in yen at

28,000,000,

with payment due in three months. The exchange rate and interest rate data are shown in the popup window:

LOADING...

.

Note that the interest rate differentials vary slightly from the forward discounts on the yen because of time differences for the quotes. The spot

118.458/$,

for example, is a mid-point range. On April 11, the spot yen traded in London from

119.317/$

to

117.598/$.

Krystal's Japanese competitors are currently borrowing yen from Japanese banks at a spread of two percentage points above the Japanese money rate. Krystal's weighted average cost of capital is

16%,

and the company wishes to protect the dollar value of this receivable.

3-month options are available from Kyushu Bank: call option on

28,000,000

at exercise price of

118.000/$:

a

1.1%

premium; or a put option on

28,000,000,

at exercise price of

118.000/$:

a

3.7%

premium.

a. What are the costs and benefits of alternative hedges? Which would you recommend, and why?

b. What is the break-even reinvestment rate when comparing forward and money market alternatives?

Spot exchange rate:	118.458/$ (closing mid-rates)
1-month forward rate:	117.942/$, a 5.25% per annum premium
3-month forward:	116.917/$, a 5.27% per annum premium
1-year forward:	112.735/$, a 5.08% per annum premium
Click on the icon located on the top-right corner of the data table in order to copy its contents into a spreadsheet.

Money Rates	United States	Japan	Differential
One month	4.9250%	0.09500%	4.83000%
Three months	4.9625%	0.09875%	4.86375%
Twelve months	5.3375%	0.31875%	5.01875%
Click on the icon located on the top-right corner of the data table in order to copy its contents into a spreadsheet.

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