Question: Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Japan for 42,000,000. The purchase was

  1. Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Japan for 42,000,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in Japanese yen rather than dollars, CVT is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

    The spot exchange rate is JPY112/USD

    The six month forward rate is JPY120/USD

    CVT's forecast for 6-month spot rates is JPY110/USD

    The budget rate, or the highest acceptable purchase price for this project, is $400,000 or 105/$

    Current borrowing rate in Japan is 4%.

    If CVT chooses to hedge its transaction exposure in the forward market at the available forward rate, the required amount in dollars to pay off the accounts payable in 6 months will be:

    $3,750,000.

    $350,000

    $375,000.

    $370,000

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