Hedge Ratio

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DEFINITION of 'Hedge Ratio'

1. A ratio comparing the value of a position protected via a hedge with the size of the entire position itself.

2. A ratio comparing the value of futures contracts purchased or sold to the value of the cash commodity being hedged.

BREAKING DOWN 'Hedge Ratio'

1. Say you are holding $10,000 in foreign equity, which exposes you to currency risk. If you hedge $5,000 worth of the equity with a currency position, your hedge ratio is 0.5 (50 / 100). This means that 50% of your equity position is sheltered from exchange rate risk.

2. The hedge ratio is important for investors in futures contracts, as it will help to identify and minimize basis risk.

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