Suppose that the current Bid-Offer on the Yen is $0.0089/¥ and $0.0091/¥, and the three-month forward is $0.0094/¥.
1. If you wish to hedge 10,000,000 Yen Obligation due in three months, what position would you take? Explain why.
a. Buy Yen forward at $0.0089/¥
b. Sell Dollars forward at $0.0091/¥
c. Sell Yen forward at $0.0094/¥
d. Buy Dollars forward at $0.0094/¥
e. Buy Yen forward at $0.0094/¥
To hedge a 10,000,000 Yen obligation due in three months, you need to take a position that will offset any potential currency fluctuations and lock in a fixed exchange rate.
The Bid-Offer on the Yen is $0.0089/¥ and $0.0091/¥, and the three-month forward rate is $0.0094/¥.
To determine the best position, we need to compare the forward rate with the Bid-Offer rates.
Option a: Buy Yen forward at $0.0089/¥
In this option, you would lock in a forward exchange rate lower than the current Bid-Offer rates. It means that you can buy Yen in the future at a cheaper rate. However, since you have a Yen obligation, this position would expose you to potential losses if the Yen appreciates against the Dollar. Therefore, this option is not suitable for hedging your Yen obligation.
Option b: Sell Dollars forward at $0.0091/¥
In this option, you would lock in a forward exchange rate higher than the current Bid-Offer rates. It means that you can sell Dollars in the future at a higher rate. Since you have a Yen obligation, this position would offset the potential appreciation of the Yen. Therefore, this option is a potential hedging strategy as it helps protect the value of your Yen obligation.
Option c: Sell Yen forward at $0.0094/¥
In this option, you would lock in a forward exchange rate higher than the current Bid-Offer rates. However, selling Yen forward is not suitable for hedging a Yen obligation because it exposes you to potential losses if the Yen depreciates against the Dollar. Therefore, this option is not recommended.
Option d: Buy Dollars forward at $0.0094/¥
In this option, you would lock in a forward exchange rate higher than the current Bid-Offer rates. However, buying Dollars forward is not suitable for hedging a Yen obligation because it exposes you to potential losses if the Yen appreciates against the Dollar. Therefore, this option is not recommended.
Option e: Buy Yen forward at $0.0094/¥
In this option, you would lock in a forward exchange rate higher than the current Bid-Offer rates. It means that you can buy Yen in the future at a higher rate. Since you have a Yen obligation, this position would offset the potential appreciation of the Yen. Therefore, this option is a potential hedging strategy as it helps protect the value of your Yen obligation.
Based on the analysis, the recommended position to hedge your 10,000,000 Yen obligation due in three months would be to buy Yen forward at $0.0094/¥ (option e).