LEXCO Co. just agreed to a long-term deal in which it will export products to Japan. It needs funds to finance the production of the products that it will export. The products will be denominated in dollars. The prevailing U.S. long-term interest rate is 9% versus 3% in Japan. Assume that interest rate parity exists and that LEXCO believes that the international Fisher effect holds.
a. Should LEXCO finance its production with yen and leave itself open to the exchange rate risk? Explain.
b. Should LEXCO finance its production with yen and simultaneously engage in forward contracts to hedge its exposure to exchange rate risk?
c. How could LEXCO achieve low-cost financing while eliminating its exposure to exchange rate risk?