International Financial Management 6th Edition by Sanjiv Eun, Cheol Resnick, Bruce Sabherwal

Exercise 18

Princess Cruise Company (PCC) purchased a ship from Mitsubishi Heavy Industry. PCC owes Mitsubishi Heavy Industry 500 million yen in one year. The current spot rate is 124 yen per dollar and the one-year forward rate is 110 yen per dollar. The annual interest rate is 5% in Japan and 8% in the U.S. PCC can also buy a one-year call option on yen at the strike price of $.0081 per yen for a premium of.014 cents per yen.
(a) Compute the future dollar costs of meeting this obligation using the money market hedge and the forward hedges.
(b) 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.
(c) At what future spot rate do you think PCC may be indifferent between the option and forward hedge