Brickfields Sdn. Bhd. needs to borrow $10 million for the next year to support its U.S. operations. It can borrow U.S. dollars at 7 percent or Japanese yen at 1 percent. It has no other cash flows in Japanese yen. Assume that interest rate parity holds, so the one-year forward rate of the yen exhibits a premium in this case. Brickfields expects that the spot rate of the yen will appreciate but not as much as suggested by the one-year forward rate of the yen.

Required:

a) Should Brickfields consider financing with yen and simultaneously purchasing yen one year forward to cover its position? Explain.

(6 marks)

b) If Brickfields finances with yen without covering this position, is the effective financing rate expected to be above, below, or equal to the Japanese interest rate of 1 percent? Is the effective financing rate expected to be above, below, or equal to the U.S. interest rate of 7 percent? Explain.

(7 marks)

c) Explain the implications if Brickfields finances with yen without covering its position and the future spot rate of the yen in one year turns out to be higher than today's one-year forward rate on the yen.

(7 marks)