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Assume the following:

The current exchange rate for the Japanese yen is 110.05.

The 120-day US interest rate is 1.895%.

The 120-day Japanese interest rate is -.050%.

The 120-day forward rate for Japanese yen is 109.40.

A US firm is required to make a payment of 12,000,000 to a supplier in 120 days.

1. If the value of the Japanese yen does not change, what will the dollar cost of the payment be?

2a. Describe how the firm can hedge the transaction risk associated with the payment using a money market hedge.

b. What will the dollar cost of the payment be if the firm hedges the transaction risk with a money market hedge and the spot exchange rate for Japanese yen in 120 days turns out to be 109.00?

3a. Describe how the firm can hedge the transaction risk associated with the payment using a forward market hedge.

b. Explain what will happen using this forward market hedge if the spot exchange rate in 120 days is 109.00.

4. Describe how the firm can hedge the transaction risk associated with the payment using a currency option. (Specify whether the firm should buy a call or put option on the Japanese yen, what expiration date it should select, and other choices it must make in connection with this approach to managing the transaction risk.)

5. How could the firm hedge the transaction risk associated with this payment by exposure netting or funds adjustment?

6. How can the firm use leading or lagging to its advantage in connection with this payment?

7. How would the answers to the previous questions change in the firm expected to receive a payment of 1,000,000 in 120 days rather than making a payment?

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