A forward contact to buy US$40 000 for a planned purchase transaction of US$50 000 has a hedge ratio of:
A) 40%.
B) 125%.
C) 80%.
D) 20%.

Question

Quizplus · Accepted Answer

The hedge ratio is calculated by dividing the value of the planned transaction (US$50,000) by the value of the forward contract (US$40,000). So, the hedge ratio is 125%. However, this is an over-hedge as the contract value is greater than the transaction value. To lessen the over-hedge, the buyer should reduce their forward contract size to US$40,000/1.25 = US$32,000, which will give a hedge ratio of 80%. Thus, the best choice is C, with a hedge ratio of 80%.

A Forward Contact to Buy US$40 000 for a Planned