Jacksonville Corp. is a U.S.-based firm that needs $600,000. It has no business

Question

Jacksonville Corp. is a U.S.-based firm that needs $600,000. It has no business in Japan but is considering one-year financing with Japanese yen, because the annual interest rate would be 5 percent versus 9 percent in the United States. Assume that interest rate parity exists.

a. Can Jacksonville benefit from borrowing Japanese yen and simultaneously purchasing yen 1 year forward to avoid exchange rate risk? Explain.

b. Assume that Jacksonville does not cover its exposure and uses the forward rate to forecast the future spot rate. Determine the expected effective financing rate. Should Jacksonville finance with Japanese yen? Explain.

c. Assume that Jacksonville does not cover its exposure and expects that the Japanese yen will appreciate by 5 percent, 3 percent, or 2 percent, and with equal probability of each occurrence.Use this information to determine the probability distribution of the effective financing rate. Should Jacksonville finance with Japanese yen? Explain

Explanation / Answer

a)

if it borrows and simulatenouly purchase yen ,then it has to pay a forward premium and offset the interest rate differential. based on parity one year forward rate is 3.8%

effective financing rate = (1+5%) (1+3.8%) -1 = 9%

b)

expedted effective financing rate =9%

the expected percentage change in japanese yen's value is 3.8%

no, since expected cost of financing with dollar is less

c)

possible change in spor rate effective financing rate probability

5% (1.05) * (1.05) -1 =10.25% 33.33%

3% (1.05) * (1.03) -1 =8.15% 33.33%

2% (1.05) * (1.02) -1 = 7.10% 33.33%   

Related Questions

Navigate

• Browse (All)
• Browse J
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.