Hedge ratio, also known as ‘beta-hedging’, is an important tool used in portfolio management and equity investing. Essentially, it is the measure of a security’s volatility — how sensitive the security’s price is to the overall market movements. The ratio is calculated by comparing the absolute market price and the standard deviation of the security price, compared to the overall market.

Hedge ratio is a useful measure for investors and portfolio managers as it can indicate the risk that a security poses, as well as the potential reward when held in a portfolio. A hedge ratio of 1 would indicate that for every one unit of the security, the price changes when the market moves by one unit — a very low risk stock or bond. Alternatively, a higher hedge ratio would indicate a much higher level of risk involved in investing in a security, as greater fluctuations in price could be seen as the market moves.

For example, a hedge ratio of 2.0 would indicate a security that is twice as risky as the market. Moreover, hedge ratios can also be used to compare returns between different markets. This can help investors make decisions on how to adjust their portfolios to maintain better diversification and return on their investments.

In summary, hedge ratio is a useful tool for investors and portfolio managers when determining the risk associated with a security and how to allocate capital in order to attain maximum returns with the least amount of risk. It is important to note, however, that hedge ratios are not guarantees of returns or protection from market losses — investors must always exercise caution and perform thorough research before investing.