Consider the following exercise concerned with management of transactions exposure. The Smedley Company has sold products to

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Consider the following exercise concerned with management of transactions exposure. The Smedley Company has sold products to a Japanese client for ¥15,000,000. Payment is due six months later. Relevant data is as follows:

Spot exchange rate: ¥105/$

Six-month forward exchange rate: ¥104/$

Japanese borrowing interest rate: 9.0%

U.S. borrowing interest rate: 7.0%

Japanese lending interest rate: 7.0%

U.S. lending interest rate: 5.0%

Size of futures contracts: ¥1,000,000 Term to settlement of contracts: six months Transactions cost on ¥15,000,000 forward contract: $500 Discuss the implications associated with each of the non-options-based methods for managing the transactions exposure risk associated with this extension of credit. Determine which hedging strategy is likely to be optimal and why.

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