Two principle methods of better controlling the impact of FX exposure

On-balance-sheet hedging is achieved when a financial institution has a matched maturity and foreign currency balance sheet.

Off-balance-sheet hedging occurs through the purchase of forwards for institutions that choose to remain unhedged on the balance sheet.

On-balance-sheet hedging:

Assets	Liabilities
USD 50 million U.S. loan, 1-year maturity, in USD, yield 8% USD 50 million equivalent Swiss loans, 1-year maturity, made in CHF, yielding 13%	USD 50 million U.S. CDs, 1-year maturity, in USD, yielding 6% USD 50 million Swiss CDs, 1-year maturity, raised in CHF, yielding 10%

Off-balance-sheet hedging:

Assets	Liabilities
USD 50 million U.S. loan, 1-year maturity, in USD, yield 8% USD 50 million equivalent Swiss loans, 1-year maturity, made in CHF, yielding 13%	USD 50 million U.S. CDs, 1-year maturity, in USD, yielding 6%

1. The U.S. bank sells USD50 million for Swiss francs at the spot exchange rate today and receives USD50,000,000/USD1.7/CHF = CHF29,411,765.

2. Immediately after the sale, the bank lends the CHF29,411,765 to a Swiss customer at 13 percent for one year.

3. In addition, the bank sells the expected principal and interest proceeds from the franc loan forward for U.S. dollars at today's forward rate (say, USD 1.65/CHF) for 1-year delivery:

(USD1.65-USD1.70)/USD1.70 = -2.94%

The forward buyer of the francs will pay USD54,838,235 to the seller when the bank delivers the CHF33,235,294 proceeds of the loan to the financial institution seller.

CHF29,411,765(1.13)*USD1.65/CHF = CHF33,235,294*USD1.65 = USD54,838,235

4. At the end of one year, the Swiss borrower repays the loan to the bank plus interest in Swiss francs (CHF33,235,294).

5. The bank gives the CHF33,235,294 to the buyer of the 1-year forward contract and receives USD54,838,235.

By using this method, the bank knows it has locked in a guaranteed return of 9.68 percent on the Swiss francs (assuming, of cource, the loan will not default and the forward buyer does not renege on the forward contract).

(USD54,838,235-USD50,000,000)/USD50,000,000=0.0968=9.68%