Suppose a company owes 250 million Yen to one of its suppliers and the payment is due in three months time.  Currently, the spot exchange rate is Yen 105 per dollar.  The three month money market interest rate in Canada is 5% per annum and in Japan it is 3% per annum.

Required:  

a) Assume that the company will use a money market hedge to eliminate the foreign exchange risk associated with this payable, and calculate what it will cost in Canadian dollars to do so.  

Compute the cost as of the payment date in three months time, not in Present Value terms.

Your calculations should include:

 i) Which currency would you borrow in?  Yen or dollars?

ii)  Amount to borrow today

iii) Cost in three months time to repay the loan

b) At what forward rate would the company be indifferent between the money market hedge you designed in part (a) above and a forward hedge involving a purchase of the required Yen using a three month forward contract?

Answer rating: 100% (QA)

a To eliminate the foreign exchange risk associated with the payable the company can use a money mar... View the full answer