Nevada Co. is a U.S. firm which has no subsidiaries in foreign countries, but it does a great deal of exporting to and importing from Japan. All those transactions are invoiced in U.S. dollars. Nevada plans to replace some of its dollar-denominated debt with Japanese yen-denominated debt, since Japanese interest rates are low. It will obtain yen-denominated debt at an interest rate of 4%.
By doing so, however, Nevada will face exchange rate risk. If the yen appreciates against the dollar, it will require more dollars to make the loan payments. It cannot effectively hedge the exchange rate risk resulting from this debt because of the price of derivatives contracts. How could Nevada Co. take advantage of the low interest rate on the yen-denominated debt and reduce its exposure to the exchange rate risk, without moving its operations?
Borrow an equal amount in U.S. dollars.
Offer to pay a higher interest rate in order to obtain protection against exchange rate risk.
Borrow as little as possible in Japan, in order to minimize the exchange rate risk.
Invoice some of its exports in yen, and use the yen to make the loan payments.