1. What is Hedge Ratio?

The Hedge Ratio (HR) is a measure used in financial risk management to determine the optimal proportion of hedging instrument needed to offset the risk of a position in the underlying asset. In the Australian context, it's particularly important for managing currency and commodity risks.

2. How Does the Calculator Work?

The calculator uses the Hedge Ratio formula:

Where:

• \( Cov(Asset, Hedge) \) — Covariance between the asset and hedge instrument returns
• \( Var(Hedge) \) — Variance of the hedge instrument returns

Explanation: The ratio indicates how many units of the hedging instrument are needed to hedge one unit of the underlying asset.

3. Importance of Hedge Ratio

Details: Accurate hedge ratio calculation is crucial for effective risk management in Australian markets, particularly for:

• Currency hedging for international investments
• Commodity price risk management
• Portfolio immunization strategies

4. Using the Calculator

Tips:

• Enter covariance and variance as decimal values
• Variance must be positive (non-zero)
• For Australian markets, use data specific to AUD-denominated instruments

5. Frequently Asked Questions (FAQ)

Q1: Why is hedge ratio important in Australia?
A: Australia's economy is heavily dependent on commodity exports and foreign investment, making hedging crucial for managing currency and price volatility.

Q2: What's a typical hedge ratio range?
A: Ratios typically range between 0 and 1, with 1 indicating perfect correlation. Negative values indicate inverse relationships.

Q3: How often should hedge ratios be recalculated?
A: In volatile Australian markets, monthly or quarterly recalculation is recommended as relationships between assets and hedges can change.

Q4: What data sources are best for Australian markets?
A: Use ASX data for equities, RBA for currency data, and relevant commodity exchanges for physical goods.

Q5: Are there limitations to this approach?
A: The basic hedge ratio assumes linear relationships and constant volatility, which may not hold in all Australian market conditions.