A Canadian importer needs $500,000 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 1.20 USD/CADtrades for 0.0325 CAD per call on 1 USD.If,by the September expiration date,the USD depreciates to 1.23 USD/CAD,how much did the firm lose (in CAD)from hedging with the option,compared to remaining unhedged?

Question

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The firm would need to buy USD at the market rate of 1.23 USD/CAD if it remained unhedged, costing them 500,000 * 1.23 = 615,000 CAD. With the call option, they can buy USD at 1.20 USD/CAD, costing 500,000 * 1.20 = 600,000 CAD. The cost of the call option is 0.0325 CAD * 500,000 = 16,250 CAD. The total cost with hedging is 600,000 + 16,250 = 616,250 CAD. The difference between remaining unhedged (615,000 CAD) and hedging (616,250 CAD) is 1,250 CAD. However, the question asks for the loss from hedging compared to remaining unhedged, which is the cost of the option, 16,250 CAD, since the actual transaction costs (buying USD at 1.23 vs. 1.20) nearly offset each other except for the cost of the option itself.

A Canadian Importer Needs $500,000 U