1. Explain the nature of the exchange-rate risk for each of the following, from
ID: 1161986 • Letter: 1
Question
1. Explain the nature of the exchange-rate risk for each of the following, from the perspective of the U.S. firm or person. In your answer, include whether each is a long or short position in foreign currency. a. A small U.S. firm sold experimental computer components to a Japanese firm, and it will receive payment of 1 million yen in 60 days. b. An American college student receives a birthday gift of Japanese government bonds worth 10 million yen, and the bonds mature in 60 days. c. A U.S. firm must repay a yen loan, principal plus interest totaling 100 million yen, coming due in 60 days.
Explanation / Answer
a. Answer: For hedging its exposure to exchange rate risk, the U.S. firm must now enter into a forward exchange contract. The contract is to sell 1 million yen and receive the amount of $9,000 (=¥1,000,000 * $0.009/¥) in time period of 60 days
b. Answer: For hedging its exposure to exchange rate risk, the student must now enter into a forward exchange contract wherein the student commits to sell 100 thousand yen and receive the amount $900 ((=¥100,000 * $0.009/¥) in time period of 60 days
c. Answer: For hedging its exposure to exchange rate risk, the U.S. firm must now enter into a forward exchange contract. The contract amount is to sell $900,000 and receiving an amount of 100 million yen in time period of 60 days.
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