Question

YZ Corporation, located in the United States, has an account payable of 750-million yen payable in one year to a bank in Tokyo. The current spot rate is yen 116 per $ and the one year forward rate is yen 109 per $. The annual interest rate is 3 percent in Japan and 6 percent in the United States (assume the same lending and borrowing rates). The future (in one year) dollar cost of meeting this obligation using the money market hedge is:

Answer 1

Dollar cost of the foreign payable = $ 6,653,833.28

Step-by-step explanation:

The money market hedge would be set up as follows:

Step 1: Deposit in Yen (Tokyo)

Deposit an amount in Yen equal to

Amount to be deposited= Payable/(1+deposit rate)

= 750,000,000/(1.03)

= Yen 728,155,339.8

Step 2 : Convert the sum

Convert Yen 728,155,339.8 at the spot rate of yen 116 per $

Dollar amount = 728,155,339.8 / 116

= $ 6,277,201.205

Step 3: Borrow at home (US)

Borrow $ 6,277,201.205 for one year at an interest rate of 6%

Amount due (inclusive of interest) = Amount borrowed × 1.06

=$ 6,277,201.205 × 1.06

= $ 6,653,833.28

Dollar cost of the foreign payable = $ 6,653,833.28