Question

Explain the nature of the exchange-rate risk for each of the following, from the perspective of the U.S. firm or person. In your answer, include whether each is a long or short position in foreign currency.

a. A small U.S. firm sold experimental computer components to a Japanese firm, and it will receive payment of 1 million yen in 60 days.
b. An American college student receives a birthday gift of Japanese government bonds worth 10 million yen, and the bonds mature in 60 days.
c. A U.S. firm must repay a yen loan, principal plus interest totaling 100 million yen, coming due in 60 days.

Answer 1

a. U.S. firm has long position in yen since it has asset in yen.

b. An American student has long position in yen since it has asset of bonds in yen.

c. U.S. firm has liability position in yen, therefore it is short position.

Step-by-step explanation:

a. The payment is to be received in next 60 days which means there is a risk of yen depreciation and then company will receive lower dollars. The company should hedge its exchange rate risk by selling yen now and buying dollars later.

b. The gift received in the form of bonds will mature in 60 days. There is uncertainty in dollar rate, if dollar appreciates against yen then student will receive less yen.

c. The dollar rate is unpredictable for yen in next 60 days. If yen appreciate then dollar will depreciate against yen and therefore amount of loan repayment will increase.