Hedge ratio

[FrankCFA]

From curriculum 6.1.1.
Kwun Tong has a short position of EUR8,000,000 coming due on a HKD/EUR forward contract. The market value of the EUR-denominated assets has increased (measured in EUR). Yang expects the HKD/EUR spot rate to depreciate.
Solution: the foreign-currency value of the underlying assets has increased; Yang recognizes that this implies that she should increase the size of the hedge greater than EUR8,000,000. She also believes that the HKD/EUR spot rate will depreciate, and recognizes that this implies a hedge ratio of more than 100%…..
Why hedge ratio of more than 100%? underlying asset has inscreased so hedge ratio should be decreased? Thanks!

 

[cfa.tor]

I think you should look at it from the point of view of the base currency (or currency in which the assets are held). When the base currency appreciates, the hedge ratio decreases and vice versa.

 

[The Song of the]

There are two separate reasons that the hedge amount will increase above EUR 8,000,000.
The first is that the value of the underlying asset has increased and so EUR 8,000,000 is no longer enough to hedge the exposure. Accordingly, to fully hedge the asset and maintain the hedge ratio the trader must increase the size of the hedge.
Next is the trader’s tactical trading decision to overweight her hedge in order to capture the depreciation of the HKD/EUR. Unlike a passive hedger, the trader has a discretionary hedging mandate. In other words, she can take directional currency bets within certain bands to enhance overall returns. Here the amount she is overweight on the hedge (the part over 100% of the hedge ratio) is speculation and not a hedge.

 

[FrankCFA]

The Song of the Broad Axe wrote:
There are two separate reasons that the hedge amount will increase above EUR 8,000,000.
The first is that the value of the underlying asset has increased and so EUR 8,000,000 is no longer enough to hedge the exposure. Accordingly, to fully hedge the asset and maintain the hedge ratio the trader must increase the size of the hedge.
Next is the trader’s tactical trading decision to overweight her hedge in order to capture the depreciation of the HKD/EUR. Unlike a passive hedger, the trader has a discretionary hedging mandate. In other words, she can take directional currency bets within certain bands to enhance overall returns. Here the amount she is overweight on the hedge (the part over 100% of the hedge ratio) is speculation and not a hedge.

Thanks The Song of the Broad Axe! It’s clear and very helpful.