Nagzira Machine Tools must pay USD 2 million in six months. The six-month forward is 84.40; a six-month dollar call struck at 84.50 costs 0.90 rupee per dollar. Compare the forward and the option if the rate ends at 82.00, 84.50 or 87.00.

The forward costs Rs 16.88 crore in every outcome; the option costs Rs 16.58 crore at 82.00 and Rs 17.08 crore at 84.50 or above. The option is cheaper only if the rate ends below 83.50; above that the forward wins by up to Rs 20 lakh. Doing nothing costs Rs 17.40 crore at 87.00. With a budget of 85.00, both hedges protect it, and the forward does so for less unless Nagzira expects a meaningful rupee rally.

Work all three choices on one line per outcome. The forward fixes the cost at USD 2 million times 84.40, Rs 16.88 crore, whatever happens; the call costs the lower of the market rate and 84.50, plus the 0.90 premium, so Rs 16.58 crore at 82.00 and Rs 17.08 crore at 84.50 and at 87.00; staying open costs Rs 16.40, Rs 16.90 and Rs 17.40 crore. The premium is paid in every case, which is the detail that decides most comparisons of this kind.

Above the strike the option is exercised and costs 85.40 a dollar, always 1.00 worse than the forward. Below the strike it is abandoned, so Nagzira buys in the market and the premium is a sunk cost. The option catches up with the forward only when the market rate plus 0.90 falls to 84.40, which means a final rate of 83.50, about 1.1% below the forward. So the option is a bet that the rupee strengthens by more than its premium, with protection if it does not.

Think of a fixed-price contract with a builder against a contract with a ceiling and a fee: the fee buys the chance to pay less if material prices fall, and you pay it whether or not they do. Nagzira's budget is 85.00, and both hedges keep it inside: the forward at 84.40, the option at worst 85.40, but the forward is cheaper in every outcome above 83.50, so unless the CFO has a real reason to expect the rupee to strengthen more than about a rupee, the forward is the better hedge. The option earns its premium in two situations: when the payment itself is uncertain, for instance if the order could be cancelled, because an unused option simply lapses while an unused forward must be closed out at whatever it is worth; and when the company is competing against a rival that is unhedged and would gain if the rupee rallied.

State the limits. The premium is paid today and the comparison ignores its interest cost, about 0.03 rupee a dollar at 7% for six months, which moves the crossover slightly lower. The forward needs a credit line with the bank and may need margin if it moves against Nagzira; the bought option, once paid for, needs neither. Rules on which exposures can be hedged and with what documentation apply to both; confirm the current framework with the bank. And the outcomes are three points on a continuous range: the honest summary is the crossover rate, not a table of three cases.