The U.S. sales subsidiary of a Japanese television set manufacturer is contractually committed to paying a flxed lump sum of money (royalties payments) to its parent on December 31 of each year. On January 1, 1996, the royalty payment is flxed at 375 million yen, payable December 31, 1996.

The treasurer of the U.S. sales subsidiary wonders whether he should cover himself in the forward exchange or the currency options market. The spot exchange rate on January 1, 1996, is 85 yen to the dollar; 36O-day forward contracts are selling at a 2.5% annual premium, and December option contracts are available for a 3.6% cash premium for a strike price of 81 yen per dollar.

A recently released econometric forecast lists annual inflation rates in the United States and Japan at 5% and 1 %, respectively, in 1996. Furthermore, the Japanese balance of trade is projected to run a surplus of $60 billion and the U. S.

balance of trade to run a deflcit of $135 billion for 1996.

Should the management of the U. S. sales company cover itself in the forward exchange market? Is the information provided sufflcient to reach a meaningful decision? What are the other covering techniques that should be considered?