optimal hedge ratio
In FX hedging with futures contracts, the optimal hedge ratio is the number of futures contracts required to hedge a given exposure. As an example, a Candadian farmer has signed a contract to sell 800,000 pounds of live cattle to a U.S. supermarket in three months’ time, at USD 1.65/pound. The spot USD-CAD rate is 1.1111.
What number of contracts should be used to hedge the resulting CAD 1,466,652 exposure? If contract size is CAD 100,000, then the farmer should buy 14.7 contracts, which is then rounded to 15.