Illustrate the option hedge versus forward hedge

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Reference no: EM131844059

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.

At what future spot rate do you think PCC may be indifferent between the option and forward hedge? What happens if the option hedge dominates the forward hedge (meaning the option hedge is cheaper)?

Is there any break even future spot rate? Provide a graph to illustrate the option hedge versus forward hedge: dollar cost of securing yen payable.

Reference no: EM131844059

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