5) Raider Inc., an American importing firm anticipates an outflow of ¥893 millio

Question

5) Raider Inc., an American importing firm anticipates an outflow of ¥893 million in 6 months. Raider's management team is worried about the course of the VS exchange rate over the next 6 months and decides to hedge. The current spot and forward rates are So-121 ¥/S and Ft-6 months-125 ¥/S. The $-interest rate is 5.56% and the ¥-interest rate is 0.48% a. Compute the S cost to Raider Inc. if it hedges its position using the forward b. Compute the S cost to Raider Inc. if it hedges its position using the money market. d. Alternatively, Raider Inc. is contemplating the use of an options hedge. Sanwa i. Call option on ¥893 million at K121 YS, with a 3.3% premium (price as ii. Put option on ¥893 million at K121 YS, with a 2.75% premium (price as e. What is the cost of the option hedge? (Hint : show the cost for the worst case market. Which of the two above hedges is best for Raider Inc.? bank is offering to Raider Inc. the following options: c. a percent of current spot rate) a percent of current spot rate) scenario) f. Compute the break-even rate between the options hedge and the better one of the forward and money market hedges. How does the break-even rate help you decide on which hedge to use?

Explanation / Answer

a) Hedging by using forward contract:

Payment in $ = 893/125 = $7.144 million

b) Hedging by using Money Market

Deposit in Japan Such amount that after 6months it will be 893 Yens.

So, Amount to be deposited = 893/(1+0.0024) = 890.862

For that amount to be deposited, $ required = 890.862/121 = $7.3625

We have to borrow $7.3625 in US and deposit in Japan. So, after 6 months the amount deposited in Japan will amount to 893 million Yen with interest and the bank will pay that amount to the supplier. In US, we have to repay the the loan of $7.3625 with interest which amounts to:

7.3625*1.0278 = $7.5672 million

c) As the payment is lower in Forward contract, Hedging its position using forward contract is preferrable.

d) As the Raider Inc. is US importer, he will have a fear of $ becoming weak and there is a $ option available. Therefore, he will enter put option.

e) Worst case scenerio in put option is not exercising the option and paying the premium.

Assuming Spot after 6months is 125Yens/$, Payment = (893/125) + (893/125)(2.75%*6/12) = $7.24223

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