The current spot rate for the $ (US Dollar) to ¥ (Yen) exchange rate is 120. General Electric plans to purchase manufacturing equipment from a Japanese supplier with payment due one year from today in Yen. GE is offered a one-year currency forward contract priced at 116 ¥ (Yen) per $ (US Dollar) to hedge a $ to Yen conversion at the end of one year. GE’ is able to borrow at 1.5% for one year in $’s and invest at 1.25% in $’s and is able to borrow at 0.5% in Yen for one year and invest for one year at 0.25% in Yen. What is the fair value of the forward contract for GE? Should the company buy the forward? Why?
The current spot rate for the $ (US Dollar) to ¥ (Yen) exchange rate is 120. General Electric plans to purchase manufacturing equipment from a Japanese supplier with payment due one year from today in Yen. GE is offered a one-year currency forward contract priced at 116 ¥ (Yen) per $ (US Dollar) to hedge a $ to Yen conversion at the end of one year. GE’ is able to borrow at 1.5% for one year in $’s and invest at 1.25% in $’s and is able to borrow at 0.5% in Yen for one year and invest for one year at 0.25% in Yen. What is the fair value of the forward contract for GE? Should the company buy the forward? Why?
Chapter7: International Arbitrage And Interest Rate Parity
Section: Chapter Questions
Problem 42QA
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- The current spot rate for the $ (US Dollar) to ¥ (Yen) exchange rate is 120. General Electric plans to purchase manufacturing equipment from a Japanese supplier with payment due one year from today in Yen. GE is offered a one-year currency forward contract priced at 116 ¥ (Yen) per $ (US Dollar) to hedge a $ to Yen conversion at the end of one year. GE’ is able to borrow at 1.5% for one year in $’s and invest at 1.25% in $’s and is able to borrow at 0.5% in Yen for one year and invest for one year at 0.25% in Yen. What is the fair value of the forward contract for GE? Should the company buy the forward? Why?
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