Restricted Export Flexibility and Risk Management with Options and Futures

firm’s domestic currency revenue. Figure 2 illustrates this graphically. The steeper thick
line represents the firm’s domestic currency revenue if it exports Q - Qd to the foreign
market. The slope is Pf (Q - Qd). The flatter thick line represents the firm’s domestic
currency revenue if the firm exports only the minimum level, Qf , to the foreign market.
Here, the slope is only PfQf . Since the firm is export flexible, it will always choose a
sales allocation between the domestic and the foreign market that maximizes its domestic
currency revenue. In Figure 2, the domestic currency revenue is represented by the solid
part of the two thick lines, which is convex in S and piecewise linear with positive slope
everywhere. This convexity is created by the possibility to export. Inspection of equation
(2) reveals that this real option is exercised if S exceeds P_d/Pf .

The thin dashed line in Figure 2 represents the dependence of the firm’s marginal
revenue ∂R∕∂Q on the exchange rate S. For exchange rates below Pd/Pf, any additional
unit of output that exceeds (Q_d + Qf) is sold in the domestic market. Hence, marginal

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