IBM, whose global sales are generally dollar denominated, finds it has excess ca
ID: 1249746 • Letter: I
Question
IBM, whose global sales are generally dollar denominated, finds it has excess cash of$8,500,000,000, which it can invest for up to three years. It has determined that its best options are either a three-year Euro-dollar ($) deposit paying 2.75% or a three-year yen denominated deposit paying 1.75% since it expects the yen to appreciate 0.9% per annum against the dollar over the next three years. Using cash flow analysis determine the best currency option in which IBM should invest. Be sure to show your complete calculations of the annual return on each investment at the end of the three-year term. Assume that the annual interest amount is reinvested, i.e. compounds, at the same annual interest rate.
Would your answer change if IBM revised its outlook for the yen to appreciate 1.2% per year?
Explanation / Answer
Dollar investment: FV = 8.5*1.0275^3 = 9.2207 billion Dollars Yen investment : Let exchange rate be E $/Y at t=0 Amount of Yen invested = 8.5/E billion Yens FV = (8.5/E)*1.0175^3 billion Yens Exchange rate at t=3, 1 yen = E*1.009 Dollars i.e. it is 1.009E $/Y So, it is = 8.5*1.0175^3/E * 1.009E = 9.0347 billion dollars FV of Dollar investment is more than that in Yen, so, investment in Dollar is advisable. (ANSWER) If yen appreciates by 1.25%, FV of Yen investment = 8.5*1.0175^3/E * 1.0125E = 9.0660 billion Dollars Even now it is better to invest in Dollars. (ANSWER)