Sakura Inc. (a Japanese kitchen appliance company) purchased $1 million of kitch

Question

Sakura Inc. (a Japanese kitchen appliance company) purchased $1 million of kitchen appliances from a U.S. firm, payable in 6 months. Currently, the 6-month forward exchange rate is $1=¥121.32 and the foreign exchange advisor predicts that the spot exchange rate is likely to be $1=¥123.55 in 6 months.

(1) What is the expected gain/loss from a forward hedge if the foreign exchange advisor’s prediction is correct?

(2) If you were the financial manager of Sakura, would you recommend hedging this USD payable? Why or why not?

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Explanation / Answer

1) Expected gain /loss on forward hedge = amount payable with expected spot price - amount payable with forward rate = 1000000*(123.55-121.32) = 2230000 yen gain

2) Hedging the USD payable is recommendable because as per expectations Yen is likely to depreciate and it will be more expensive to pay with spot price in the future.

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