12. XYZ Corporation, located in the United States, has an accounts payable obligation of Y750 million payable in one year to a bank in Tokyo. The current spot rate is 116 yen per dollar and the one year forward rate is 109 yen per dollar. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can buy a one-year put option on yen at the strike price of $0.0086 per yen for a premium of 0.008 cents per yen. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cents per yen. (a) (2 points) Do forward market hedge. Indicate whether to buy or sell forward. Solution: (b-1) (1 points) Now assume that the corporation would use regular' option market hedge. First, indicate whether XYZ corporations should use a put option or a call option to hedge the currency risk. Solution: (5-2) (3 points) What is the maximum total cost (in $) that the firm would end up paying by using the option market hedge? Solution