Hedge Ratio
It is a ratio that reflects the portion of investment hedged from the risk. A ratio equal to 1 or 100% indicates that the position of the investor is completely hedged. In contrast, a ratio equal to 0 expresses that the investor has made no provision for hedging his investment. It guides investors in taking positions to reduce the risk exposure. A hedge ratio calculator is made to help one in the effortless calculation.
Formula
The formula for calculating the hedge ratio is as follows:
Hedge Ratio = Hedge Value / Total Position Value
About the Calculator / Features
The hedge ratio calculator effortlessly calculates the ratio by entering only the following figures:
- Hedge value
- Total position value
Calculator
How to Calculate using Calculator
For calculating the hedge ratio using a calculator, the user is required to insert the following details into the calculator:
Hedge Value
Hedge value means the portion of the portfolio that the investor has hedged. For example, an investor hedges 20% of his investment; then, the hedge value is equal to 20% of the total portfolio value.
Total Position Value / Portfolio Value
The total position value or Portfolio Value is the current market value of the portfolio. The market value of a portfolio position can be either more or less from its original value. If, after the hedge, this value increases, the hedge ratio will effectively decrease as the portfolio value has increased. The investor is free to make adjustments to his hedged percentage/position depending upon his risk exposure level as well as his view of the market. Similarly, a decrease in this value will increase the hedge ratio.
Example
Let us take an example for more clarity. Assume that the portfolio of Mr. X has a value of $25,000. And he hedges 60% of the value of portfolio, that is, $15,000 (25,000 * 60%).
Here, the hedge ratio is 60%. But let us consider the following cases to make the concept more simple and easy to understand.
Case 1
If total position value changes to $28,000
Hedge Ratio = 15,000 / 28,000 = 0.54
Interpretation
Due to an increase in total position value, the hedge ratio has decreased from 60% to 54%. This simply means that the risk exposure of investment has increased. Here, the investor is required to adjust his position to minimize this risk.
Case 2
If total position value changes to $21,500
Hedge Ratio = 15,000 / 21,500 = 0.69
Interpretation
Here, a decrease in the value of the total position has increased the hedge ratio. This simply means that the portion of the risk in the overall portfolio has reduced, and the portion hedged from risk has increased from 60% to 69%. This ultimately means that the position of the investor is more secured from risk than earlier.
Final Words
It defines the risk in the investor’s portfolio and serves as a guideline to minimize this risk. One can get an estimate of his risk position. However, it is a difficult task to arrive at a perfect hedge ratio in practical life.
