Suppose that the U.S. firm Halliburton buys construction equipment from the Japanese firm Komatsu at a price of ¥250 million. The equipment is to be delivered to the United States and paid for in one year. The current exchange rate is ¥100 = $1. The current interest rate on one-year U.S. Treasury bills is 6%, and on one-year Japanese government bonds the interest rate is 4%.
a. If Halliburton exchanges dollars for yen today and invests the yen in Japan for one year, how many dollars does it need to exchange today in order to have ¥250 million in one year?
b. If Halliburton enters a forward contract, agreeing to buy ¥250 million in one year at an exchange rate of ¥98 = $1, how many dollars does it need today if it plans to invest the dollars at the U.S. interest rate of 6%?
c. If Halliburton invests today at the U.S. interest rate of 6%, without entering into any other type of contract, does the firm know how many dollars it needs today to fulfill its equipment contract in one year? Briefly explain.
d. Which method(s) described in (a) through (c) provide(s) a hedge against exchange-rate risk? Which do(es) not? Which method is Halliburton likely to prefer?
e. What does the forward contract exchange rate have to be in (b) in order for the results in (a) and (b) to be equivalent?