Hedge ratio
Capital MarketsThe proportion of a forecast exposure that is actually covered, which for a corporate is normally well below all of it.
Also written: hedge cover, hedge coverage
Hedging is not binary, and treating it as a yes or no question is one of the clearer signs of an inexperienced answer. What a treasury sets is a ratio and a profile: a high proportion of the next couple of quarters, a lower proportion of the year after, little or nothing beyond that. The disclosure is often in the annual report, and it tells you how long the reported margin is insulated from a move in the underlying price.
There are two real reasons the ratio is not 100%. The first is forecast error. A hedge sized against a volume that never materialises is not a hedge, it is an outright position, and a company that over hedges has taken a directional bet without meaning to. That risk grows with tenor, which is exactly why cover declines with distance.
The second is competitive. In an industry where rivals reprice with the spot market, being the only fully hedged producer means carrying an above market cost while everyone else cuts price. Whether that is a problem depends on pricing power: a differentiated producer can hold price, and a producer selling into a market clearing price cannot.
The useful analytical move is to read a hedge ratio as a clock rather than a shield. A company hedged 80% for two quarters and 30% for the year after has told you roughly when the current market price starts reaching its income statement, and roughly how long management has to respond.
Worked example
Illustrative. A manufacturer covers 90% of the next two quarters, 50% of the two quarters after that, and nothing beyond twelve months.
Input prices then rise sharply. Only a tenth of the increase reaches the first two quarters, half of it reaches the next two, and the whole of it lands from the second year, unless the company has repriced by then.
The hedge did not stop the increase. It staged its arrival, which is the whole purpose.