In 1985, Japan Airlines (JAL) bought $3 billion of foreign exchange contracts at ¥180/$1 over 11 years to hedge its purchases of U.S. aircraft. By 1994, with the yen at about ¥100/$1, JAL had incurred more than $1 billion in cumulative foreign exchange losses on that deal. a. What was the economic rationale behind JAL’s hedges? b. Did JAL’s forward contracts constitute an economic hedge? That is, is it likely that JAL’s losses on its forward contracts were offset by currency gains on its operations?
In September 1992, Dow Chemical reacted to the currency chaos in Europe by switching to Euro pricing for all its products in Europe. The purpose, said a Dow executive, was to shift currency risk from Dow to its European customers. Moreover, said the Dow executive, the policy was fairer: By setting the same DM price throughout Europe, Dow’s new policy would nullify any advantage that a Dow customer in one company might have over competitors in another country based on currency swings. a. What is Dow really trying to accomplish with its new pricing policy? b. What is the likelihood that this new policy will reduce Dow’s currency risk? c. How are Dow’s customers likely to respond to this new policy?
Lyle Shipping, a British company, has chartered out ships at fixed U.S. dollar freight rates. How can Lyle use financing to hedge against its exposure? How will your recommendation affect Lyle’s translation exposure? Lyle uses the current rate method to translate foreign currency assets and liabilities. However, the charters are off-balance sheet items.In 1990, a Japanese investor paid $100 million for an office building in downtown Los Angeles. At the time, the exchange rate was ¥145/$1. When the investor went to sell the building five years later, in early 1995, the exchange rate was ¥85/$1 and the building’s value had collapsed to $50 million. a. What exchange risk did the Japanese investor face at the time of his purchase? b. How could the investor have hedged his risk?
Gizmo, U.S.A. is investigating medium term financing of $10 million in order to build an addition to its factory in Toledo, Ohio. Gizmo’s bank has suggested the following alternatives: Type of loan Rate 3-year U.S. dollar loan 3-year Euro loan 3-year Swiss franc loan 14 8 4 a. What information does Gizmo require to decide among the three alternatives? b. Suppose the factory will be built in Geneva, Switzerland, rather than Toledo. How does this affect your answer in part a?
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