P&G Limited considers hedging its receivables of 500000 due in 4 months. It can obtain a forward contract to purchase Euro in 4 months. The forward rate of the Euro for the same period is $1.25, the same rate as currency futures contracts on Euros.

As a second alternative, P&G Limited can use the money market to hedge its receivables. The spot rate of Euro is $1.15 today. Moreover, the European money market interest rate is 5% for 4 months while the money market interest rate for the same period is 6% in the USA.

As a third alternative, the company can hedge its receivables with a currency option. A suitable option with an exercise price of $1.24, a premium of $0.03, and an expiration date of 4 months from now is available. Assume that P&Gs forecasts for the spot rate of the Euro at the time payments are due are as follows:

• $1.20 (20% probability)
• $1.23 (30% probability)
• $1.26 (30% probability)
• $1.28 (20% probability)

Finally, the company may apply a strategy for hedging its receivables 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:

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