Question: IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed 250 million payable in 1 year. Currently, the spot exchange rate is

IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed 250 million payable in 1 year. Currently, the spot exchange rate is 105/$ and the 1 year forward rate is 100/$. The 1 year money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Japan. The management of IBM are considering using a forward contract or a money market hedge to deal with this yen account payable.

a. What type of exposure does IBM face?

b. What should IBM use: a forward buy or sell, and of which currency? Why?

c. Briefly explain the process of a money market hedge and calculate the dollar cost of meeting the yen obligation at maturity via a money market hedge.

d. Which hedging alternative would you recommend? Why?

e. What type of foreign currency option could be used to hedge this exposure?

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