As at 1st January, 2017, the spot exchange rate between the U.S. dollar and Japanese Yen was trading at $1.00 equivalent to ¥100. The local bank offered the Company to exchange $1.00 for ¥102 on 31st December, 2017. The Interest rates on one year government bonds were 6% in U.S. and 10% in Japan. The company can borrow and lend at the risk-free rate on government bonds. As an Investment Advisor you have been approached for advice by the CEO on the most profitable option that he should take: Under option 1, he is contemplating borrowing in dollars on 1st January, exchange for Yen, enter into a forward contract to exchange Yen for dollars in one year, and invest the Yen for one year. The second option entails borrowing in Yen on January 1, exchange for dollars, enter into a forward contract to exchange dollars for Yen in one year, and invest the dollars for one year. Required: With the help of detailed explanations and steps, advise the CEO on the most profitable option that the company must take.
As at 1st January, 2017, the spot exchange rate between the U.S. dollar and Japanese Yen was trading at $1.00 equivalent to ¥100. The local bank offered the Company to exchange $1.00 for ¥102 on 31st December, 2017. The Interest rates on one year government bonds were 6% in U.S. and 10% in Japan. The company can borrow and lend at the risk-free rate on government bonds. As an Investment Advisor you have been approached for advice by the CEO on the most profitable option that he should take:
Under option 1, he is contemplating borrowing in dollars on 1st January, exchange for Yen, enter into a forward contract to exchange Yen for dollars in one year, and invest the Yen for one year.
The second option entails borrowing in Yen on January 1, exchange for dollars, enter into a forward contract to exchange dollars for Yen in one year, and invest the dollars for one year.
Required:
With the help of detailed explanations and steps, advise the CEO on the most profitable option that the company must take.
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