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Hedging by Currency Derivatives. (25 points). Your best friend, Kaori Oda, lives in Japan and works for Tecmo-Koei Company, a Japanese game company that exports game products to foreign countries. She asks your advice for the currency hedging for their company’s foreign operations. So, please think of Japan as the domestic country and the Japanese yen (JPY) as the domestic currency in this analysis. Today is October 27, 2021.

The company has unearned revenue of USD 1 million and expects to receive it on January 27, 2022 (we assume this is in 90 days). We assume that the standardized January currency futures and options settle on January 27, 2022, and each USDJPY futures contract is with USD 100,000.

Here is the market information:
As of October 27, the USDJPY spot exchange rate is 113.00, with the quoted three-month futures exchange rate 112.50. On December 27, you discover that the January USDJPY futures is quoted at 119.00, and the spot rate is 119.40.

On October 27, the market quotes for the available USDJPY options with January maturity are:

X (strike rate in USDJPY) 111.00
113.00
116.50

USD Calls / JPY Puts 2.57
1.42
0.99

USD Puts / JPY Calls 0.33
1.89
4.12

Where X represents the strike exchange rate in USDJPY, the premiums are expressed in JPY (i.e., 1.42 equals JPY 1.42), and the option’s underlying exchange rate is based on the value of one unit of the USD in terms of the JPY (or USDJPY).

Questions:
Items a to g are based on the following information. This company would like to hedge by entering some units of the January USDJPY foreign exchange futures contract on October 27.

a. What is the JPY change in this company’s underlying position (the USD 1 million unearned revenue to be received) from October 27 to December 27? (3 points)

b. What is the hedging position of the USDJPY future contracts? (to buy or to sell? how many units?) (2 points)

c. What is the basis of each future contract on October 27? (2 points)
d. What is the total profit or loss on the futures hedging position as of December 27 denominated in the JPY? [Hint: when you mark a future contract to market, always use the future exchange rates maturing on the same day, not the spot exchange rates. Make sure to multiply the profit or loss from each futures contract by the number of future contracts you entered.] (3 points)

e. What is the basis of each future contract on December 27? (2 points)
f. What is the JPY change in this company’s overall position from October 27 to December 27? (2 points)

g. Is this hedge by future contracts perfect? (1 point) Why? (1 point)