Purchasing yen one year forward to avoid exchange rate risk

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Reference no: EM131911184

Jacksonville Corp. is a U.S.-based firm that needs $500,000. It has no business in Japan but is considering one-year financing with Japanese yen, because the annual interest rate would be 5 percent versus 9 percent in the United States. Assume that interest rate parity exists.

1. Can Jacksonville benefit from borrowing Japanese yen and simultaneously purchasing yen one year forward to avoid exchange rate risk? Explain.

2. Assume that Jacksonville does not cover its exposure and uses the forward rate to forecast the future spot rate. Determine the expected effective financing rate. Should Jacksonville finance with Japanese yen? Explain.

3. Assume that Jacksonville does not cover its exposure and expects that the Japanese yen will appreciate by either 5 percent, 3 percent, or 2 percent, and with equal probability of each occurrence. Use this information to determine the probability distribution of the effective financing rate. Should Jacksonville finance with Japanese yen? Explain.

Reference no: EM131911184

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