Hedge ratio

The number of units of the underlying held per option to make the combined position riskless over the next period. In the binomial model, the change in option value over the change in the underlying's price.

Where you will meet it

Hedge ratio appears in 8 learning outcomes on the CFA syllabus. A few of them:

• Explain the binomial model for valuing options and what each of its terms means
  CFA Level II · Derivatives and Risk Management

  “Value comes from a riskless hedge of h units of the underlying per option, where the hedge ratio is h = (c+ − c−) ÷ (S+ − S−).”

• Assess liability-driven strategies across a range of interest rate scenarios and choose the one that best meets the portfolio's goals
  CFA Level III · Portfolio Management Pathway

  “A hedge ratio below 100% leaves a deliberate bet that rates will rise.”

• Propose and defend an asset allocation designed around a set of liabilities
  CFA Level III · Asset Allocation

  “If the plan is underfunded, the basic design fails and a partial hedge or higher return-seeking allocation is needed, possibly with a glide path that raises the hedge ratio as funded status improves.”

• Explain the approach known as liability-driven investing
  CFA Level III · Portfolio Construction

  “The core tool is matching the money duration (basis point value) of assets to that of liabilities so the surplus is protected from rate changes; hedge ratio = asset BPV ÷ liability BPV.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with H · Glossary