When a seller quotes an export price for a product or receives an offer in terms of foreign currency, there is concern with the exchange rate fluctuations that may occur before the seller receives payment. When quoting prices in terms of the foreign currency, the exporter knows how many dollars are to be received at the current rate of exchange. However, when the customers pays in Sterling Pounds, Deutschmarks, Indian Rupees, Japanese Yen or some other acceptable foreign currency, the amount received in terms of dollars will depend upon the rate of exchange when the currency is converted. When the price is quoted in the foreign currency, the exporter accepts the risk of exchange fluctuation. Unless steps are taken to protect expected profits, a decline in exchange rates may reduce profits or even convert them into a loss. Exporter’s Means of Protection An American exporter can obtain protection against exchange Continue reading
International Trade Finance
Foreign Exchange Restrictions
Although the direct intervention methods referred to have influenced many exchange rates, they do not fully serve the needs of countries with a continuous shortage of foreign exchange. To supplement the direct measures many countries adopted a number of foreign exchange restrictions. Most countries have employed foreign exchange restrictions from time to time. Developing countries especially have found restrictions necessary to secure compliance with their development plans. An exchange restriction plan implies that the government restricts the uses to which the available supply of exchange shall be put. Foreign exchange may be allocated specially for the payment of import bills, interest on foreign loans, and on other specific purposes. Sometimes the restrictions prevent the use of exchange for trade with a given (unfriendly) country. In the latter case the purpose may be political, but the basic reason for most foreign exchange restrictions is the shortage of foreign exchange sufficient to Continue reading
Forex Operational Risk Management through Production Management
There are four production related strategies available to deal with foreign exchange operational risk. These are input-mix, plant location, relocation of production and cost cutting. Input-mix: Global sourcing is a great strategy to deal with operating risk. In a survey of 152 manufacturing companies world over, the Machinery and Allied Products Institute, a research firm, found that 77% of them had increased their global sourcing since the rise of the dollar, which rises dollar cost. This is as it should be. The principal effect of a real exchange rate change is to change the price of domestically produced goods relative to foreign goods. A well-managed firm should be searching constantly for ways to substitute between domestic and imported inputs, depending on the relative prices involved and the degree of substitution possible. Plant Location: A firm without foreign facilities exporting to a competitive market, whose currency has devalued against currency of Continue reading
History and Development of Currency Options and Futures
Options and Futures have been a feature of trade since ancient times. Futures and options have been around as long as there has been commerce, because commerce involves risk. In the last two decades or so, such risks have grown almost exponentially, and these volatile trading conditions have created substantial growth in the use of futures and options. In the global integration; the use of Futures and Options products has changed the financial world. Futures and Options are used to manage external business risks. It is therefore interesting to note that the phenomenal growth in their use coincided with the collapse of Bretton Woods fixed exchange rate regime and the suspension of the dollar’s convertibility into gold. Exchange rates suddenly became much more volatile and because interest rates affect and are effected by exchange rates, so interest rates also became much more volatile. A method of managing risk was required. Continue reading
International Payments Using Drafts
Commonly used in international trade, a draft is an unconditional order in writing – usually signed by the exporter (seller) and addressed to the importer (buyer) or the importer’s agent – ordering the importer to pay on demand, or at a fixed or determinable future date, the amount specified on its face. Such an instrument, also known as a bill of exchange, serves three important functions: To provide written evidence, in clear and simple terms, of financial obligation. To enable both parties to potentially reduce their costs of financing. To provide a negotiable and unconditional instrument (that is, payment must be made to any holder in due course despite any disputes over the underlying commercial transaction.) Using a draft also enables an exporter to employ its bank as a collection agent. The bank forwards the draft or bill of exchange to the foreign buyer (either directly or through a branch Continue reading
National Competitive Advantage Theory of International Trade – Porters Diamond Model
It is a fact that Porter (1990) never focused primarily on the factors determining the pattern of trade, yet his theory of national competitive advantage does explain why a particular country is more competitive in a particular industry. If, for example, Italy maintains competitive advantage in the production of ceramic tiles and Switzerland possesses the competitive advantage in watches, it can be interpreted that the former will export ceramic tiles and the latter will export watches and both of them will import goods in which their own industry is not competitive. Why is this there a difference? Porter explains that there are four factors responsible for such diversity. He calls those factors the “diamond of national advantage”. The Porters diamond model includes: Factor conditions Demand conditions Related and supporting industries Firm strategy, structure and rivalry These factors have been more or less taken into account by earlier economists. What is Continue reading