Assume today is 30 April 2020. A Japanese firm is seeking permission from its government to import defence equipment from an American firm for a sum of Japanese Yen (JPY) 50 million. The outcome of the application will only be known at the end of May 2020. The sales contract is contingent upon the import approval. If so, the sum will be paid by the Japanese firm at the end of July 2020.

Today, you obtained a table of futures prices (below) for JPY/USD contracts.

Expiry:

July 2020 Bid

USD per JPY 0.009327

Expiry:

July 2020 Offer

USD per JPY 0.009333

Expiry:

August 2020 Bid

USD per JPY 0.00926

Expiry:

August 2020 Offer

USD per JPY 0.00932

. Which firm faces exchange rate risk? Describe the nature of the risk.

(5 marks)

b. Today, the firm at risk decided to conduct a futures hedge. Explain the choice of bid or offer futures price, and the choice of maturity month to hedge the currency exposure. Which is the relevant futures price?

(10 marks)

c. For the futures contract hedge:

i) Explain if a long hedge or short hedge should be implemented.

(5 marks)

ii) Calculate the required number of futures contracts for the hedge.

(5 marks)

This weblink provides the JPY/USD futures contract specifications:

https://www.cmegroup.com/trading/fx/g10/japanese-yen_contract_specifications.html

d. As the Japanese government may reject the import order, which financial derivative would be a better hedging alternative, and why? Describe the nature of this hedging alternative. (10 marks)

e. The Financial Controller of the firm at risk takes a pessimistic view on the US dollar. She forecasts that the spot USD/JPY rate at the end of July 2020 to be 200 ticks away from the spot rate today. Assuming that she is correct, calculate the net receipt in local currency terms. (15 marks)

This weblink provides historical USD/JPY spot rates:

https://www.xe.com/currencycharts/?from=USD&to=JPY&view=1Y

Note: Students to adjust the selected rate(s) to 2 decimal places.