Question

How can the below example be handled via a call option approach?
style=”background-color:rgb(230,230,230);color:rgb(17,17,17);”>Venezuela’s current exchange rate is 9.8750 Bolivar(VEF) for 1USD, so for 1 million dollars we get 9,875,000 VEF. It has been this rate for the past 90 days, making it 0% change of volatility. Lets imagine that the spot rate decreases to .90 instead of a dollar, our payment will be 8,887,500, with a foreign exchange loss of 987,500 USD. Because future exchange rates are never certain, companies try to mitigate loss with derivative instruments. For this example, to avoid this transaction exposure, the US company can go into a forward hedge (covered transaction) which will lock in the exchange rate in case it drops in the future. Now of course, the rate can also increase, however both companies have to honor the contractual rate. Part of hedging means that no increase in cash flow will occur.

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