Krystal is a U.S.-based company which manufactures, sells, and installs water purification equipment. On April 11th 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 ¥20,000,000, with payment due in three months.

Spot exchange rate:..................¥118.255..........¥118.255/$ (closing mid-rates)

One-month forward rate:............¥117.760.........................................5.04%

Three-month forward:.................¥116.830........................................4.88%

One-year forward: ...................¥112.450........................................5.16%

Additional information: Aquatech's Japanese competitors are currently borrowing yen from Japanese banks at a spread of 2 percentage points above the Japanese money rate. Aquatech's weighted average cost of capital is 16%, and the company wishes to protect the dollar value of this receivable.
Three-month options from Kyushu Bank:
* Call option on ¥20,000,000 at exercise price of ¥118.00/$: a 1% premium.
* Put option on ¥20,000,000, at exercise price of ¥118.00/$: a 3% premium.
a) What are the costs and benefits of alternative hedges? Which would you recommend, and why?
b) What is the breakeven reinvestment rate when comparing forward and money market alternatives?

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Money Rates One month Three months Twelve months Differential 4.78125% 4.84375% 4.87500% United States 4.8750% 4.9375% 5.1875% Japan 0.09375% 0.09375% 0.31250%