Reference no: EM132070168

Your firm (a U.S. firm) needs some cash to fund operations for the next 12 months–about $100 million. For the past few years, you have noticed that the competitors have been borrowing money in Japan and your boss keeps mentioning the near-zero short-term government rates in Japan. While there are a lot of psychological barriers and it just seems like it will be a major pain in the neck, you finally decide to think about borrowing in yen. You call your bankers for a quick indication of the 1-year rates you would likely face in each currency–the indication is 5% in the US market and 2.5% in the Japanese market. Your firm does have operations in Japan, which might facilitate taking out a yen loan. You actually need dollars for operations so you will convert the loan proceeds at the spot rate and you will be paying the loan back at the end of the year with dollar funds converted to yen. The current spot and 1 year forward rates are 110.00¥/$ and 107.38¥/$, respectively.

a) How many dollars will you need to repay the yen loan if you cover it (i.e., fix the dollars required for yen repayment) with a forward contract? Compute the effective dollar interest rate. How does it compare to the actual dollar interest rate? (You may round the percentage dollar interest rate to the second decimal point, e.g., 1.23%.)

b) If you took the yen loan and you did not cover the loan by the forward contract, what directional bet (e.g., appreciate/depreciate) on the yen are you actually making? (I am expecting just one or two lines of response with no numerical analysis here.)

c) If the actual ¥/$ spot rate turns out to be 105¥/$ one year from now, will this prove or disprove UEH (Unbiased Expectations Hypothesis, or the Forward Parity)?