Suppose I have a USD holding of 1,000,000 in my portfolio and I want to convert it into EUR in a month's time. I enter into a FX forward contract of the same amount USD 1,000,000, meaning that I have a hedge ratio of 100%. If the portfolio holding is now worth $990,000, is my hedge ratio 990,000/1,000,000?

  • 1
    $\begingroup$ Yes, you will experience a Hedging Error because ex-post the hedge ratio is not exactly 1 but 1.01 This means your hedged return will experience some unwanted return as a result of EURUSD fluctuations. But this is far less than what you would have experienced if you had not hedged at all. $\endgroup$
    – nbbo2
    Jun 8, 2020 at 20:57
  • $\begingroup$ Sorry, I thought the hedge ratio was 0.99..How did you get 1.1? $\endgroup$
    – junior_pm
    Jun 8, 2020 at 21:01
  • $\begingroup$ 1,000,000/990,000. You have a bigger hedge than you really need. You can repatriate 1,000,000 USD into EUR at a fixed rate but you will only need 990,000. So you are short USD to the extent of 10,000; you will benefit if USD goes down, instead of being indifferent to USD fluctuations as you wanted to be. $\endgroup$
    – nbbo2
    Jun 8, 2020 at 21:06


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