FINC6013 Workshop 6 Questions & Solutions
Chapter 3
PROBLEMS
6. Intel is scheduled to receive a payment of ¥100,000,000 in 90 days from Sony in connection with a shipment of computer chips that Sony is purchasing from Intel. Suppose that the current exchange rate is ¥103/$, that analysts are forecasting that the dollar will weaken by 1% over the next 90 days, and that the standard deviation of 90-day forecasts of the percentage rate of depreciation of the dollar relative to the yen is 4%.
a. Provide a qualitative description of Intel’s transaction exchange risk.
Answer: Intel is a U.S. company, and it is scheduled to receive yen in the future. A weakening of the yen versus the dollar causes a given amount of yen to*…show more content…*

Any weakening of the yen versus the dollar will increase the yen cost of your grain. The possible loss is unbounded. b. Explain two ways to hedge the risk. Answer: You could hedge your risk by buying dollars forward at ¥106.02/$. Alternatively, you could determine the present value of the dollars that you owe and buy that amount of dollars today in the spot market. You could borrow that amount of yen to avoid having to pay today. c. Which of the alternatives in part b is superior? Answer: If you do the forward hedge, you will have to pay ¥106.02/$ [pic]$377,287 = ¥39,999,967.74 in 90 days. If you do the money market hedge, you first need to find the present value of $377,287 at 3.25%. The de-annualized interest rate is (3.25/100) [pic] (90/360) = 0.008125. Thus, the present value is $377,287 / 1.008125 = $374,246.25 Purchasing this amount of dollars in the spot market costs ¥106.35/$ [pic] $374,246.25 = ¥39,801,088.69 To compare this value to the forward hedge, we must take its future value at 1.9375% p.a. The de-annualized interest rate is (1.9375/100) [pic] (90/360) = 0.00484375, and the future value is ¥39,801,088.69 [pic] (1.00484375) = ¥39,993,875.21 The cost of the money market hedge is essentially the same as the cost of the forward hedge because interest rate parity is satisfied. 8. You are a sales manager for Motorola and export

Any weakening of the yen versus the dollar will increase the yen cost of your grain. The possible loss is unbounded. b. Explain two ways to hedge the risk. Answer: You could hedge your risk by buying dollars forward at ¥106.02/$. Alternatively, you could determine the present value of the dollars that you owe and buy that amount of dollars today in the spot market. You could borrow that amount of yen to avoid having to pay today. c. Which of the alternatives in part b is superior? Answer: If you do the forward hedge, you will have to pay ¥106.02/$ [pic]$377,287 = ¥39,999,967.74 in 90 days. If you do the money market hedge, you first need to find the present value of $377,287 at 3.25%. The de-annualized interest rate is (3.25/100) [pic] (90/360) = 0.008125. Thus, the present value is $377,287 / 1.008125 = $374,246.25 Purchasing this amount of dollars in the spot market costs ¥106.35/$ [pic] $374,246.25 = ¥39,801,088.69 To compare this value to the forward hedge, we must take its future value at 1.9375% p.a. The de-annualized interest rate is (1.9375/100) [pic] (90/360) = 0.00484375, and the future value is ¥39,801,088.69 [pic] (1.00484375) = ¥39,993,875.21 The cost of the money market hedge is essentially the same as the cost of the forward hedge because interest rate parity is satisfied. 8. You are a sales manager for Motorola and export

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