Suppose you are the CEO of a Japanese company that produces computers and exports them to the US. The price for a computer is always $700, and the dollar-yen forward with maturity at the end of next year is traded at ¥108/$. An analysis of the current market situation yields the following possible scenarios for the next year: In the baseline scenario (Scenario 1), the dollar-yen spot exchange rate is ¥100/$, and you sell 55,000 computers. In Scenario 2, the exchange rate is ¥110/$ and you sell 50,000 computers, while in Scenario 3 the exchange rate goes to ¥85/$ and you sell 57,000 computers. You assume that Scenario 1 will occur with probability 1/3, Scenario 2 with probability 1/2, and Scenario 3 with 1/6. Assume for simplicity that all customers pay for their computers at the end of next year.
a) Quantify the overall foreign exchange exposure of your company by calculating an appropriate measure.
b) Is the value of your measure rather “low” or “high”? Relate the value of the measure to transaction exposure and other economic foreign exchange exposure of the company.
c) What would you do to hedge the foreign exchange exposure? Describe the hedge including all related cash-flows.
d) Does the hedge completely eliminate the foreign exchange exposure? If not, why not?