Question Details

Assume that Jacksonville does not cover its exposure 



1. Probability Distribution of Financing Costs. Missoula, Inc., decides to borrow Japanese yen for
one year. The interest rate on the borrowed yen is 8 percent. Missoula has developed the following
probability distribution for the yen- degree of fluctuation against the dollar:
Possible Degree of Fluctuation Percentage
of Yen Against the Dollar Probability
-4% 20%
-1% 30%
0% 10%
3% 40%
Given this information, what is the expected value of the effective financing rate of the Japanese
yen from the U.S. corporation- perspective?


2. Analysis of Short-term Financing. Jacksonville Corp. is a U.S.-based firm that needs $600,000.
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.
a. Can Jacksonville benefit from borrowing Japanese yen and simultaneously purchasing yen
one year forward to avoid exchange rate risk? Explain.

b. 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.

c. 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.




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