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% (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?

Question

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If IBM invests in U.S. T-bills, it would earn a return of 1.810% over six months, yielding a total of $1,009,050 after six months. However, if IBM converts the dollars to yen and invests in Japan, it would earn a return of 13%, which gives a total yen value of ¥113,000,000 after six months. 
Now, if IBM does not hedge the investment, it is exposed to exchange rate risk because the yen may appreciate against the dollar, reducing the dollar value of the investment when converted back. However, IBM can hedge against this risk by short selling the forward contract. Doing so would allow IBM to lock in the exchange rate, and the firm will receive $1,027,272 after six months, which is far higher than the $1,009,050 it would earn from investing in U.S T-bills. Therefore, IBM's best choice is to take $1 million, translate it into yen at the spot, invest in Japan, and hedge with a short position in the forward contract.

Suppose That You Are the Treasurer of IBM with an Extra