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Forward/Spot = (1+ Japan's interest rate)/(1+ US interest rate)

Ya, what he said!!!

Maybe they don't go back to yen right away -- maybe they reinvest in dollars

Yes, but as the forward rate goes out it takes this into account. At some time the money is repatriated to Yen and the exchange rate will eat the difference in interest rate returns.

So for three years
(1+ Japan's interest rate)^3/(1+ US interest rate)^3




2. They can hedge their risk at the start of the thing with a forward or futures contract.

And the hedge they would get into right now is for interest rates in Japan at 0% and interest in the US at 5% all calculated out.

The risk that is hedged in this case is say for Disney Tokyo. They have a cash inflow of yen and they want dollars, so they will purchase forwards to ensure that they get the set amount of dollars for yens and thus they hedge away the exchange rate risk. If the exchange rate goes the other way, well Disney loses some extra take but that is the nature of insurance.

Thanks Rivet.

DrTarr






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