Conduct the cash flow analysis of the money market hedge

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Reference no: EM131881532

a. IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ¥250 million payable in three months. Currently, the spot exchange rate is ¥105/$ and the three-month forward rate is ¥100/$. The three-month money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Japan. The management of IBM decided to use the money market hedge to deal with this yen account payable.

(a) Explain the process of a money market hedge and compute the dollar cost of meeting the yen obligation.

(b) Conduct the cash flow analysis of the money market hedge.

b. Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €50 million which is payable in one year. The current spot exchange rate is $1.06/€ and the one-year forward rate is $1.11/€. The annual interest rate is 6.0% in the U.S. and 5.0% in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and would like to hedge exchange exposure.

(a) It is considering two hedging alternatives: sell the euro proceeds from the sale forward or borrow euros from Credit Lyonnaise against the euro receivable. Which alternative would you recommend? Why?

(b) Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods?

c. A U.S. firm holds an asset in France and faces the following scenario:

State 1	State 2	State 3	State 4
Probability	25%	25%	25%	25%
Spot rate	$1.20/€	$1.10/€	$1.00/€	$0.90/€
P^*	€1500	€1400	€1300	€1200
P	$1,800	$1,540	$1,300	$1,080

In the above table, P* is the euro price of the asset held by the U.S. firm and P is the dollar price of the asset.

(a) Compute the exchange exposure faced by the U.S. firm.

(b) What is the variance of the dollar price of this asset if the U.S. firm remains unhedged against this exposure?

(c) If the U.S. firm hedges against this exposure using the forward contract, what is the variance of the dollar value of the hedged position?

plz explain clearly for each question

Reference no: EM131881532

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