Suppose that you are the treasurer of IBM with an extra US$1,000,000 to invest for six months. You are considering the purchase of U. S. T-bills that yield 1.810% (that's a six month rate, not an annual rate by the way) and have a maturity of 26 weeks. The spot exchange rate is $1.00 = ¥100, and the six month forward rate is $1.00 = ¥110. The interest rate in Japan (on an investment of comparable risk) is 13 percent. What is your strategy?
Take $1m, invest in U. S. T-bills.
Take $1m, translate into yen at the spot, invest in Japan, and repatriate your yen earnings back into dollars at the spot rate prevailing in six months.
Take $1m, translate into yen at the spot, invest in Japan, hedge with a short position in the forward contract.
Take $1m, translate into yen at the forward rate, invest in Japan, hedge with a short position in the spot contract.
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