TWA is expecting a delivery of an aircraft engine in 180 days. It will then have to pay Rolls-Royce 20 million British pounds (GBP). While the current GBP spot rate is $1.28, TWA is willing to accept some fluctuation in its payables with the maximum amount up to $26 million. The firm is considering using call options to manage its foreign exchange exposure. It has identified a GBP currency option contract with an exercise price of $1.30 that expires exactly in 180 days. The option is currently trading at $0.02. Additionally, the firm has developed the following scenarios for GBP spot prices in 180 days:

Scenarios for GBP spot in 180 days	Probability
$1.22	10%
$1.27	30%
$1.32	40%
$1.37	20%

a) Recall that the option expiration date coincides with the firms payables due. Therefore, both exercising the option and sell-closing the position yield the same result. Determine for each scenario, whether the firm should exercise its call option or not.

Answer (complete the table below):

Scenarios for GBP spot	Prob.	Unhedged notional amount	Option exercise
$1.22
$1.27
$1.32
$1.37

b) Determine for each scenario, the differences, in US dollars, in the notional amount of the firms payables between the hedging and no hedging cases. Additionally, calculate the expected net gain/loss of hedging with the option contract, compared to not hedging at all.

Answer (complete the table below and calculate the expected net gain/loss):

Scenarios for GBP spot	Prob.	Unhedged notional amount	Option exercise	Hedging cost per unit	Hedging notional amount	Diff.
$1.22
$1.27
$1.32
$1.37