If you were to suppose that IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed 250 million payable in one year. The current spot rate is 99 yen per dollar and the one-year forward rate is 95 yen per dollar. The annual interest rate is 5% in Japan and 8% in the U.S. IBM can also buy a one-year call option on yen at the strike price of $0.01 per yen for a premium of .014 cents per yen.

1.Explain how IBM should do a forward hedge. Compute the future dollar costs of meeting this obligation using the forward hedges.

2.Assuming that the forward exchange rate is the best predictor of the future spot rate, compute the expected future dollar cost of meeting this obligation when the option hedge is used.

3.At what future spot rate do you think IBM may be indifferent between the option and forward hedge?