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Hedge Ratio

A ratio that indicates the amount of exposure reduced by hedging and reflects the relationship between the position hedged and the hedging instrument used.

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The hedge ratio quantifies the effectiveness of a hedging strategy in reducing risk exposure, calculated by dividing the value of the hedging instrument by the value of the hedged position. It is essential in financial risk management, particularly when using derivatives. A 1:1 hedge ratio implies a completely hedged position, while a ratio of less than 1 indicates that only a portion of the risk is mitigated. The hedge ratio helps in determining the number of derivatives needed to obtain a desired level of risk protection and is crucial for companies looking to manage price, currency, or interest rate risks.
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