On balance sheet hedging of FX exposure

[afterworkguinness]

Hello,
I'm a bit confused by the terminology used in the on balance sheet hedging example in the notes (example comes from Saunders chapter 14). On the liability side why are we "lending GBP @ 11%" aren't we recording the cost of funding and isn't lending (long bond) an asset ?

Also, how is this hedging ?

Cheers



Also, in this chapter there is reference is US and UK CDs, what are these ? Currency Derivatives?

 

[ShaktiRathore]

HI,
CDs are certificates of deposites are the deposit made by customer to bank a interest rate for a short term like 1 yr in this case and are not any cuurrency derivatives.
Lending means the bank is raising $200mn at 8% and 0 pound at 11% so that the bank raises net liability of 200+0=$200mn
This the bank invest in assets in US$100 at 9% and remaining 100/1.6 pound at 15% in british assets. Thus total values of investment after 1 yr is 1.09*100+(100/1.6)*1.45*1.15 USD mn=213.21USD mn=> ROA=213.21-200/200=13.21/200=6.61%
liabs afer 1 year=200*1.08=216 USD mn
so the net return afer 1 yr for the investor=213.21-216/200=-2.8/200=-1.4% is the ROI.
this is not an hedging example but to hedge we should enter into a futures or forward contract on currency which is not present here.
thanks

 

[afterworkguinness]

Thanks for your answer Shakti.