Question: General Electric sold a machine system to a customer in the UK and billed 30 million payable in one year. GE is concerned with the

General Electric sold a machine system to a customer in the UK and billed 30 million payable in one year. GE is concerned with the pound proceeds from international sales and would like to control exchange rate risk. The current spot exchange rate is $1.29/ and one-year forward exchange rate is $1.27/ at the moment. GE can buy a one-year put option on 30 million with a strike price of $1.32/ for a premium of $0.02 per pound. It can also buy a one-year call option on 30 million with a strike price of $1.29/ for a premium of $0.15 per pound. Currently, oneyear interest rate is 5.1% in the U.K. and 4.0% in the U.S.

a. Compute the guaranteed dollar proceeds from the sale if GE decides to hedge using a forward contract.

b. If GE decides to hedge using money market instruments, what action does GE need to take? What would be the guaranteed dollar proceeds from the sale in this case?

c. If GE decides to hedge using options on pounds, what option (put or call) will GE use? And what would be the expected dollar proceeds from the aircraft sale? Assume that GE regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.

d. Based on the available information and your calculations above, what is your recommendation to GE for a best strategy (forward hedge vs money market hedge vs options hedge)? Why?

e. Other things being equal, at what forward rate would GE be indifferent between the forward and money market hedge?

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