Suppose that you are the treasurer of IBM with an extra U.S.$1,000,000 to invest for six months.You are considering the purchase of U.S.T-bills that yield 1.810 percent (that's a six month rate,not an annual rate by the way)and have a maturity of 26 weeks.The spot exchange rate is $1.00 = ¥100,and the six month forward rate is $1.00 = ¥110.The interest rate in Japan (on an investment of comparable risk)is 13 percent.What is your strategy?
A)Take $1m,invest in U.S.T-bills.
B)Take $1m,translate into yen at the spot,invest in Japan,and repatriate your yen earnings back into dollars at the spot rate prevailing in six months.
C)Take $1m,translate into yen at the spot,invest in Japan,hedge with a short position in the forward contract.
D)Take $1m,translate into yen at the forward rate,invest in Japan,hedge with a short position in the spot contract.

Question

Quizplus · Accepted Answer

Investing in Japan offers a higher interest rate (13%) compared to the U.S. T-bills (1.810%). By converting dollars to yen at the current spot rate and then hedging the investment with a short position in the forward contract, you lock in the exchange rate for converting yen back to dollars in six months, mitigating currency risk while benefiting from the higher interest rate.

Suppose That You Are the Treasurer of IBM with an Extra