IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ¥250 million payable in three months. Currently, the spot exchange rate is ¥111/$ and the three-month forward rate is ¥107/$. The three-month money market interest rate is 8 percent per annum in the U.S. and 6 percent per annum in Japan. (“per annum” means annualized) The management of IBM decided to use the money market hedge to deal with this yen accounts payable. (Remember to convert the annualized interest rates to 3 month rates assuming a 360 day year.)
(a) Explain the process of a money market hedge and compute the dollar cost of meeting the yen obligation in 3 months.