This article is provided by Alt21 Limited, trading as Alt21, an FCA authorised payments and FX provider and is intended for UK businesses considering FX hedging as part of their treasury activity. All examples provided are illustrative only and not a current or guaranteed rate. FX hedging products carry risk, including the risk that rates move against you and that you may be asked to provide collateral at short notice, which could affect your cash flow. Comments from Toby Osborne, CFO at Alt21 are contained within the article. As an Alt21 employee, his comments reflect his own experience working with Alt21’s clients and describe Alt21’s own products and approach, rather than independent market commentary. Please read the full disclaimer at the bottom of the page.
You’ve decided to hedge. Now comes the harder question:
How much?
Hedge too little and exchange rate movements can still have a meaningful impact on the costs or revenue you’re trying to plan around.
Hedge too much and you could commit to an amount your business ultimately doesn’t need if forecasts or payment timings change.
There isn’t a percentage that works for every business. Your exposure, forecast reliability, time horizon and commercial objectives all matter.
So rather than starting with “What percentage should we hedge?”, this guide looks at the information behind that percentage, from how reliable the underlying exposure is to how that confidence changes over time.
Quick summary
A hedge ratio shows how much of an exposure you’re hedging compared with the total exposure.
For example:
- £1 million exposure and £750,000 hedged = 75% hedge ratio
- £1 million exposure and £500,000 hedged = 50% hedge ratio
- £1 million exposure and £250,000 hedged = 25% hedge ratio
But there isn’t one hedge ratio that’s appropriate for every business.
The percentage you choose may depend on how reliable your forecasts are, when the exposure is expected, how much movement in exchange rates your business is prepared to accept and what you’re trying to achieve through hedging.
That means the better question to ask is “How much of this exposure are we comfortable committing to hedge?”
What is a hedge ratio?
A hedge ratio compares the value of the position you’ve hedged with the value of your total exposure.
The basic calculation is:
Hedge ratio = hedged exposure ÷ total exposure
Multiply the result by 100 to express it as a percentage.
For example:
If your business expects to pay €800,000 to suppliers over the next six months and you’ve hedged €400,000 of that exposure, your hedge ratio is:
€400,000 ÷ €800,000 = 0.5
Or 50%.
At one end of the scale, a 0% hedge ratio means none of the exposure has been hedged. At the other, 100% means you’ve hedged an amount equal to the full identified exposure.
The percentage tells you how much you’ve hedged. What it doesn’t tell you is whether that amount fits your business.
A 90% ratio isn’t automatically more sensible than 50%, just as 50% isn’t automatically more sensible than 20%.
Context matters.
How are hedge ratios used?
For finance teams managing FX exposure, a hedge ratio can turn a vague objective like “we want to hedge some of next quarter’s dollar payments” into something measurable.
You can use FX hedge ratios to see how much of a forecast exposure is currently hedged, set parameters within an FX hedging policy and review whether your hedge still reflects the underlying exposure.
This is important because your exposure doesn’t necessarily stay still.
Suppose you’ve hedged £500,000 against an expected £1 million exposure. Your hedge ratio starts at 50%.
If your forecast exposure later falls to £800,000, the same £500,000 hedge now represents 62.5%.
If your expected exposure increases to £1.25 million, it falls to 40%.
The hedge hasn’t changed. The thing you’re hedging has.
That’s why hedge ratios can be useful as part of an ongoing process rather than a percentage you choose once and forget.
As Alt21 CFO Toby Osborne puts it:
“A hedging programme works best as an ongoing process rather than a one-off decision.”
That means reviewing not only the hedge itself, but the business assumptions sitting underneath it. Sales forecasts change, supplier requirements move, and expected payment dates slip.
If the underlying exposure changes, the percentage you’ve hedged against it may need to be reassessed too.
Types of hedge ratios
When researching hedge ratios, you’ll come across several different terms:
Simple hedge ratio
This is usually the most relevant starting point for a finance team managing identifiable FX exposures.
It simply compares:
Amount hedged ÷ total exposure
You might use it to describe the percentage of forecast supplier payments, revenue or another currency exposure you’ve hedged.
Full hedge ratio
A 100% hedge ratio means the value hedged equals the identified exposure.
That may provide greater visibility over the exchange rate applying to that exposure, depending on the hedging products being used.
But 100% doesn’t automatically mean “better”.
If your forecast changes and the underlying payment doesn’t materialise as expected, you could be left with a hedge that no longer matches your commercial requirement.
Partial hedge ratio
Anything between 0% and 100% represents a partial hedge.
For example, you might hedge 50% of an expected exposure and leave the remaining 50% unhedged.
Partial hedging can be used where a business wants some visibility over future costs while retaining exposure to future exchange rates.
Dynamic hedge ratio
Your ratio doesn’t have to remain fixed.
Some businesses review and adjust the proportion hedged as forecasts become clearer, payments approach or circumstances change.
For example, you may have considerably more confidence in the exposure expected over the next 90 days than the amount forecast nine or twelve months from now. Rather than applying the same hedge ratio across the entire period, the proportion covered could reflect those different levels of forecast confidence.
As Toby says:
“You hedge to the level that you’re confident of the future business.”
As forecasts become firmer, you can review the exposure and decide whether the proportion hedged still reflects what the business now expects to pay or receive.
The important distinction is that your hedge ratio becomes something you manage, rather than simply a number you set.
Learn more about dynamic hedging.
How do you calculate a hedge ratio?
For a straightforward FX exposure, the calculation is:
Hedge ratio = value of hedge ÷ total value of exposure
Imagine you expect to make €2 million in supplier payments over the next 12 months.
You’ve currently hedged €1.2 million.
€1.2m ÷ €2m = 0.6
Your hedge ratio is therefore 60%.
Simple enough.
But there’s another calculation finance teams need to think about before reaching for the calculator:
What counts as your exposure?
Your forecast might contain:
- Highly predictable contracted payments
- Recurring FX payments you can forecast reasonably accurately
- Sales or costs that are expected but not yet committed
- Longer-term estimates with greater uncertainty
Those exposures don’t necessarily deserve the same level of confidence.
- Contracted revenue or a committed supplier payment gives you relatively firm information about the amount involved.
- Recurring payments may also become highly predictable when you’ve got enough history behind them.
- Forecast supplier costs depend more heavily on what sits behind the forecast.
How firm is the order book?
How much can purchasing volumes change?
How quickly can the business switch suppliers?
Pipeline revenue introduces another layer of uncertainty because the expected income may depend on sales converting as forecast.
And something like an unwon tender is more uncertain still: the potential FX exposure may be significant, but the underlying business hasn’t yet materialised.
This leads to a useful principle from Toby:
“You hedge to the confidence of your exposure.”
In other words, the headline forecast isn’t necessarily the amount you treat as equally certain for hedging purposes. Understanding what sits behind that forecast can help you decide how much confidence to place in different parts of it.
Forecast confidence isn’t just a finance question
Determining how reliable an exposure is may require information from across the business.
Your sales team may have the clearest view of how much pipeline revenue is likely to convert. Procurement may know whether expected purchasing volumes are genuinely committed. Operations may know whether production plans are likely to change.
Toby explains:
“Finance shouldn’t be doing it in isolation. It works best as a conversation with the rest of the company.”
That turns the hedge ratio into more than a treasury calculation. The percentage ultimately sits on top of commercial assumptions about what the business expects to sell, buy, receive or pay.
And those assumptions can change.
Understanding the optimal hedge ratio formula
When you search for hedge ratios online, you’ll probably encounter the optimal hedge ratio, also called the minimum variance hedge ratio.
The formula is:
h = ρ × (σS ÷ σF)
Where:
- h = optimal hedge ratio
- ρ = correlation between changes in the spot and futures prices
- σS = standard deviation of changes in the spot price
- σF = standard deviation of changes in the futures price
The formula aims to find the hedge ratio that minimises the variance of the combined position. It’s particularly relevant where futures are being used to hedge an asset and the price movements of the exposure and hedging instrument aren’t identical.
Useful finance theory? Absolutely.
But the percentage your finance team uses to hedge forecast FX exposure may involve a much broader commercial decision.
A mathematical “optimal” hedge ratio can’t tell you how reliable next quarter’s sales forecast is, whether a supplier contract might change or how much certainty your budgeting process requires.
For many finance teams, the next practical step is to establish a repeatable framework for deciding how much exposure to hedge.
An FX hedging framework could consider:
Forecast reliability
How confident are you that the exposure will happen at the amount and time expected, and what information is that confidence based on?
Time horizon
How far into the future are you forecasting? Your confidence in an exposure six weeks away may be very different from one 12 months away.
Business objectives
Are you primarily trying to improve budgeting visibility, support planned margins or reduce the effect of exchange rate movements on cash flow?
Flexibility
What happens if the amount or timing of the underlying exposure changes?
Internal parameters
Does your FX policy specify minimum or maximum hedge percentages, review periods or different treatment for committed and forecast exposures?
Business input
What do sales, procurement, operations or other relevant teams know that could change your view of the exposure?
You might also be interested in learning about embedded hedging.
Example of a hedge ratio
Another way to think about forecast confidence is to separate what the business has committed to from what it may choose to do.
Imagine a three-year supplier agreement with a minimum purchase requirement but the option to buy additional volume.
The minimum contractual amount gives you much firmer information about the underlying exposure. The optional volume is different because the business may never purchase it.
Combining both into one forecast number can hide that distinction.
| Period | Forecast exposure | What sits behind it | Forecast confidence |
| Months 1–2 | €1,000,000 | Confirmed supplier orders | High |
| Months 3–4 | €1,000,000 | Expected orders based on current production plans | Medium |
| Months 5–6 | €1,000,000 | Longer-term purchasing forecast | Lower |
In this illustrative example, the business isn’t applying a lower hedge ratio to later periods simply because they’re further away.
It’s doing so because the information supporting those exposures becomes less certain further into the forecast.
The near-term supplier orders are already confirmed, while the later amounts depend increasingly on forecasts that could change.
That’s the logic behind Toby’s principle of hedging to the confidence of the exposure. As more orders become confirmed, the business can review the position and decide whether the amount hedged still reflects what it now expects to pay.
For illustration, imagine you’ve hedged:
- €800,000 of months 1–2
- €600,000 of months 3–4
- €300,000 of months 5–6
That’s €1.7 million hedged against €3 million of total forecast exposure.
€1.7m ÷ €3m = 56.7%
Your overall hedge ratio is therefore approximately 57%.
But the overall number only tells part of the story.
Your near-term hedge ratio is 80%, the middle period is 60%, and the later period is 30%.
That gives you a much clearer picture of where you’re hedged, not simply how much.
As the months pass and your forecasts become clearer, those ratios can be reviewed again.
It’s also worth looking at the ratio from the other direction.
A 60% hedge ratio means 40% of the identified exposure remains exposed to future exchange rates.
That isn’t inherently good or bad. But it helps make the decision explicit. If you’re comfortable leaving that 40% open because the underlying forecast remains uncertain, that’s different from arriving at 60% simply because it sounds like a reasonable number.
The percentage should have a reason behind it.
Make your hedge ratio part of the plan
A hedge ratio is most useful when it reflects what’s actually happening in your business.
Alt21 brings your international payments and FX hedging into one platform, so finance teams can manage currency exposure and access Forward Contracts, FX Options and other hedging tools as their needs evolve.
You can manage your positions directly through the platform, with FX specialists available when you want additional support.
Open an Alt21 account. Applicants must pass Alt21’s onboarding process and accept our terms and conditions before becoming a client.
FAQs
What is a good hedge ratio?
There isn’t a universally appropriate hedge ratio.
The percentage that fits your business depends on factors including your forecast reliability, cash flows, time horizon, commercial objectives and how much exposure to exchange rate movements you’re prepared to retain.
Rather than starting with a standard percentage, it can be more useful to understand why you’re hedging and how certain the underlying exposure is.
What does a 50% hedge ratio mean?
A 50% hedge ratio means the value you’ve hedged equals half of the identified exposure.
If you expect €1 million in payments and hedge €500,000, for example, your hedge ratio is 50%.
The remaining €500,000 isn’t covered by that hedge and remains exposed to future exchange rate movements.
What does a hedge ratio of 1 mean?
A hedge ratio of 1, or 100%, means the hedged value equals the total identified position or exposure.
In an FX context, if you have €500,000 of identified exposure and hedge €500,000, you’ve hedged 100% of that exposure.
That doesn’t mean a ratio of 1 is automatically appropriate. If the underlying exposure changes, the hedge may no longer match it.
Can a hedge ratio change?
Yes. Your hedge ratio can change because you add or remove hedges, but it can also change because the underlying exposure changes.
That’s why it’s useful to review both sides of the calculation rather than focusing solely on the amount you’ve hedged.
What’s the difference between a hedge ratio and an optimal hedge ratio?
A simple hedge ratio measures the proportion of an exposure that’s hedged.
An optimal or minimum variance hedge ratio is a statistical calculation designed to determine a hedge size that minimises variance, based on the relationship between movements in the underlying position and the hedging instrument.
Are hedge ratios the same as Sharpe ratios?
No. Despite the similar terminology, hedge ratios and Sharpe ratios measure completely different things.
A hedge ratio describes the proportion of an exposure that’s hedged. A Sharpe ratio is an investment-performance measure comparing returns above a risk-free rate with volatility.
That’s why searches for hedge fund Sharpe ratios or the Sharpe ratios of top hedge funds refer to the risk-adjusted performance of investment funds, not the percentage of a company’s FX exposure that’s hedged.
For a finance team deciding how much currency exposure to hedge, it’s the FX hedge ratio that’s relevant.
ALT21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by ALT21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. ALT21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by ALT21 Limited. Not all applications will be accepted.
