Analysis of short-term financing. Jackson Ltd is a UK-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 per cent versus 9 per cent in the UK. Assume that interest rate parity exists.

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

b Assume that Jackson does not cover its exposure and uses the forward rate to forecast the future spot rate.

Determine the expected effective financing rate. Should Jackson finance with Japanese yen? Explain.

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