Sony’s royalties payment. The U.S. sales subsidiary of the Japanese consumer electronics giant Sony Inc. is committed to paying a fixed lump sum of money

(royalties) set at 2. 5 percent of its U.S. revenue to its parent on December 31 of the previous year. On January 1, 2014, the royalty payment is fixed at US$5.75 million, payable December 31, 2014.

The treasurer of Sony-Japan wonders whether he should cover the royalty payment in the forward exchange or the currency options market. The spot exchange rate on January 1, 2014, is 85 yen to the dollar; 360-day forward contracts on the U.S. dollar are selling at a 1. 5 percent annual discount, and December option contracts are available for a 3. 6 percent cash premium for a strike price of 85 yen per dollar.

a. Sketch the hedging options available to Sony-Japan. What would be the yen proceeds under each?

b. A recently released econometric forecast projects annual inflation rates in the United States and Japan at 5 percent and 1 percent, respectively, in 2014.

Furthermore, the Japanese balance of trade is projected to run a surplus of

$160 billion and the U.S. balance of trade to run a deficit of $435 billion for 2014. Should Sony-Japan hedge its dollar receivables? How? Is the information provided sufficient to reach a meaningful decision? What are the other covering techniques that should be considered?