A Japanese EXPORTER has a €1,000,000 receivable due in one year.Spot and forward exchange rate data given in the table: The one-year risk free rates are i_$ = 4.03%; i_€ = 6.05%; and i_¥ = 1%.Detail a strategy using forward contracts that will hedge exchange rate risk. A)Borrow €970,873.79 today; in one year you owe €1m, which will be financed with the receivable.Convert €970,873.79 to dollars at spot, receive $1,165,048.54.Convert dollars to yen at spot, receive ¥116,504,854. B)Sell €1m forward using 16 contracts at the forward rate of $1.20 per €1.Buy ¥150,000,000 forward using 11.52 contracts, at the forward rate of $1.00 = ¥120. C)Sell €1m forward using 16 contracts at the forward rate of $1.25 per €1.Buy ¥150,000,000 forward using 12 contracts, at the forward rate of $1.00 = ¥120. D)None of the above

Question

Quizplus · Accepted Answer

To hedge the exchange rate risk, we need to ensure that the value of the receivable in euro is not affected by any changes in the exchange rate. 
Option A involves borrowing euro and converting it to USD and JPY at the spot rates. However, this strategy is not efficient as it does not eliminate the exchange rate risk.
Option B involves selling €1m forward and buying JPY forward using a combination of contracts. However, this strategy is not effective in hedging the exchange rate risk because it does not provide full coverage for the currency risk.
Option C is the best choice as it involves selling €1m forward and buying JPY forward using a combination of contracts. This strategy provides full coverage for the exchange rate risk because it eliminates the currency risk for both the euro and yen. The forward exchange rates for euro and yen are favorable, which means that the exporter can lock in a profit by selling euro forward and buying yen forward.

A Japanese EXPORTER Has a €1,000,000 Receivable Due in One