Given:

• Spot rate is 108.20/$
• 6-month forward rate is 106.20/$
• Teks cost of capital is 9.8%
• Japans 6-month deposit rate is 1.250% p.a.
• U. S. 6 month borrowing rate is 4.0% p.a.
• 6-month yen call option strike price = 108/$
• Option premium = 2.5%
• The expected spot rate can be estimated from the following information:

Possible Spot Rate in 180 days	Probability
101.35/$	35%
105.44/$	50%
110.21/$	15%

Remain Unhedged Convert $ to yen in 6 months.

Amount of yen payable = 8,000,000.00

Possible Spot Rate in 180 days	Total cost of buying	Probability
101.35/$		35%
105.44/$		50%
110.21/$		15%

2. Forward Hedge - buy yen forward 6-months to lock in cost

Amount of yen payable = 8,000,000

Forward rate = 106.20/$

t=0

t=180 US dollar cost of settling payable would be

3. Money market hedge - invest funds in yen deposit now .

Principal needed at the end of 6-months = 8,000,000

Japans 6-month deposit rate is 1.250% p.a.

Yen deposit needed now =

Current spot rate (/$) = 108.20/$

US dollars needed now, for exchange into yen = $73,477.92

U. S. 6 month borrowing rate is 4.0% p.a.

Find Dollar cost of money market hedge at end of 6-months:

Carry-forward rate, 6 months @ Teks WACC = 9.8% p.a.

Options Hedge - buy a call option on Japanese yen

Amount of yen payable = 8,000,000

Spot price (/$) = 108.20

Premium on call option, % = 2.500%

Cost of call option = $1,848.43

If the spot rate at end of 6-months is greater than strike rate, the option is exercised.

Possible Spot Rate in 180 days	Exercise Option?	Purchase price	Dollar cost of payable	Probability
101.35/$		108.00/$	$74,074.07	35%
105.44/$		108.00/$	$74,074.07	50%
110.21/$		110.21/$	$72,588.69	15%

Total cost of exercising call option on yen (including premium):

=