General Motors considers hedging its payable of 550000 due in 3 months. It can obtain a forward contract to purchase Euro in 3 months. The forward rate of Euro for the same period is $1.23, the same rate as currency futures contracts on Euros.

As a second alternative, General Motors can use the money market to hedge its payable. The spot rate of Euro is $1.15 today. Moreover, the European money market interest rate is 4.25% for 3 months while the money market interest rate for the same period is 5.5% in the USA.

As a third alternative, the company can hedge its payable with a currency option. A suitable option with an exercise price of $1.24, a premium of $0.04, and an expiration date of 3 months from now is available. Assume that GMs forecasts for the spot rate of the Euro at the time payable is due are as follows:

• $1.18 (30% probability)
• $1.23 (30% probability)
• $1.27 (30% probability)
• $1.29 (10% probability)

Finally, the company may apply a strategy for hedging its payable which are known as wait-and-see. Thus, they can choose to sit idle and do nothing i.e., employing the Non-hedge alternatives, as well.

Based on the above information regarding hedging alternatives:

a. Determine the cash flow under different hedging alternatives. [1 + 2 + 3 = 6 Marks]
b. How much the company should be paying under the wait-and-see strategy? [1 Marks]
c. What is the real cost of hedging under different hedging alternatives? Which hedging alternative should be exercised? Explain why? [3 Marks]