A Canadian importer needs 10 million U.S.dollars in September,and decides to buy a call option on the USD for September delivery.Suppose a call option on the USD with a September expiration and a strike price of 1.30 USD/CAD trades for 0.0515 CAD per call on 1 USD.If,by the September expiration date,the USD has appreciated to 1.25 USD/CAD,how much did the firm lose (in CAD)from hedging with the option,compared to remaining unhedged?

Question

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To hedge against currency risk, the importer bought a call option, which means they have the right but not the obligation to buy USD at the strike price of 1.30 USD/CAD. 
If the USD appreciates to 1.25 USD/CAD by the September expiration, then the importer would exercise their option and buy USD at 1.30 USD/CAD, when the market rate is 1.25 USD/CAD. Therefore, the importer would lose out on the difference of 0.05 CAD per USD.

The premium paid for the option is 0.0515 CAD per call on 1 USD, which means for 10 million USD, the importer would have bought 10 million calls at a cost of (10,000,000 x 0.0515) = 515,000 CAD.

The loss from hedging with the option is (10,000,000 x 0.05) = 500,000 CAD.

Therefore, the net loss from hedging with the option is (500,000 + 515,000) = 1,015,000 CAD or approximately 207,308 CAD more than remaining unhedged.

A Canadian Importer Needs 10 Million U