At time t, 3M borrows ¥10.8 billion at an interest rate of 0.2%, paid semiannually, for a period of two years. It then enters into a two-year yen/dollar swap with Bank of America (BofA) on a notional principal amount of $100 million (¥10.8 billion at the current spot rate). Every six months, 3M pays BofA U.S. dollar LIBOR6, while BofA makes payments to 3M of 0.3% annually in yen. At maturity, BofA and 3M reverse the notional principals. Assume that LIBOR6 (annualized) and the ¥/$exchange rate evolve as follows.

a. Calculate the net dollar amount that 3M pays to BofA (“−”) or receives from BofA (“+”) in each six-month period.

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b. What is the all-in dollar cost of 3M’s loan?

c. Suppose 3M decides at t + 18 to use a six-month forward contract to hedge the t + 24 receipt of yen from BofA. Six-month interest rates (annualized) at t + 18 are 2.9% in dollars and 1.1% in yen. With this hedge in place, what fixed dollar amount would 3M have paid (received) at time t + 24? How does this amount compare to the t + 24 net payment computed in Part a?

d. Does it make sense for 3M to hedge its receipt of yen from BofA? Explain.

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