10.7 Krystal. Krystal is a U.S.-based company that manu- factures, sells, and installs water purification equip- ment. On April 11, the company sold a system to the City of Nagasaki, Japan, for installation in Nagasaki's famous Glover Gardens (where Puccini's Madame Butterfly waited for the return of Lt. Pinkerton). The sale was priced in yen at 20,000,000, with payment due in three months. Spot exchange rate: 118.255/$ (closing mid-rates) 1-month forward rate: 117.760/$, a 5.04% per annum premium 3-month forward: 116.830/$, a 4.88% per annum premium 1-year forward: 112.450/$, a 5.16% per annum premium Money Rates United States Japan Differential One month 4.8750% 0.09375% 4.78125% Three months 4.9375% 0.09375% 4.84375% Twelve months 5.1875% 0.31250% 4.87500% Money Rates One month Three months Twelve months United States 4.8750% 4.9375% 5.1875% Japan Differential 0.09375% 4.78125% 0.09375% 4.84375% 0.31250% 4.87500% Note that the interest rate differentials vary slightly from the forward discounts on the yen because of time differences for the quotes. The spot 118.255/$, for example, is a mid-point range. On April 11, the spot yen traded in London from 118.30/$ to Y117.550/$. Aquatech's Japanese com- petitors are currently borrowing yen from Japanese banks at a spread of two percentage points above the Japanese money rate. Krystal's weighted aver- age cost of capital is 16%, and the company wishes to protect the dollar value of this receivable. 3-month options are available from Kyushu Bank: call option on 20,000,000 at exercise price of 118.00/$: a 1% premium; or a put option on 20,000,000, at exercise price of 118.00/$: a 3% premium. a. What are the costs and benefits of alterna- tive hedges? Which would you recommend, and why? b. What is the break-even reinvestment rate when comparing forward and money market alternatives? 10.7 Krystal. Krystal is a U.S.-based company that manu- factures, sells, and installs water purification equip- ment. On April 11, the company sold a system to the City of Nagasaki, Japan, for installation in Nagasaki's famous Glover Gardens (where Puccini's Madame Butterfly waited for the return of Lt. Pinkerton). The sale was priced in yen at 20,000,000, with payment due in three months. Spot exchange rate: 118.255/$ (closing mid-rates) 1-month forward rate: 117.760/$, a 5.04% per annum premium 3-month forward: 116.830/$, a 4.88% per annum premium 1-year forward: 112.450/$, a 5.16% per annum premium Money Rates United States Japan Differential One month 4.8750% 0.09375% 4.78125% Three months 4.9375% 0.09375% 4.84375% Twelve months 5.1875% 0.31250% 4.87500% Money Rates One month Three months Twelve months United States 4.8750% 4.9375% 5.1875% Japan Differential 0.09375% 4.78125% 0.09375% 4.84375% 0.31250% 4.87500% Note that the interest rate differentials vary slightly from the forward discounts on the yen because of time differences for the quotes. The spot 118.255/$, for example, is a mid-point range. On April 11, the spot yen traded in London from 118.30/$ to Y117.550/$. Aquatech's Japanese com- petitors are currently borrowing yen from Japanese banks at a spread of two percentage points above the Japanese money rate. Krystal's weighted aver- age cost of capital is 16%, and the company wishes to protect the dollar value of this receivable. 3-month options are available from Kyushu Bank: call option on 20,000,000 at exercise price of 118.00/$: a 1% premium; or a put option on 20,000,000, at exercise price of 118.00/$: a 3% premium. a. What are the costs and benefits of alterna- tive hedges? Which would you recommend, and why? b. What is the break-even reinvestment rate when comparing forward and money market alternatives
