- 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.
I understand the above which was taken from investopedia. Now to the next example from Schweser:
Appreciation of the currency (+Rfx) would make imports less expensive, which is likely to decrease productin costs, increasing profits and asset values (+Rfc). Strong positive correlation between Rfx and Rfc uncreases the volatility of Rdc. A hedge ration greater than 1.0 would reduce the volatility of Rdc.
Strong negative correlation between Rfx and Rfc naturally decreases the volatility of Rdc. A hedge ratio less than 1.0 would reduce the volatility of Rdc.
Question: wouldn’t a hedge ratio of 1 keep both volatilities stable since we are matching the exposure to the hedge in both cases? Why do we have to go above one in the former and less than 1 in the latter? Why can’t we hedge 1-1 for both an eliminate the volatility in both cases? Won’t 1-1 eliminate volatility regardless? Actually, if it is negatively correlated (latter) i would think you wouldn’t need to hedge.