Transaction risk arises from executed contracts resulting in Forex payables or receivables in the future. The domestic currency value of these payables or receivables at current exchange rate and at future exchange rate is expected to be at variance, resulting in transaction risk. The forex transaction risk can be hedged using internal strategies. Internal strategies refer to strategies that are internal to the firm and its affiliates. These are “home’ arrangements. The counter party to the transactions may be involved. But third parties are never involved. The different internal strategies used for managing forex transaction risk are: Risk Netting: This strategy involves matching forex receivables in a currency with forex payables in that currency. Both currency and time matching are needed. Suppose an US firm has Yen 10 mn receivable from and Yen 7 mn payable to same counter party, both having 90 days to mature. These two transactions can Continue reading
International Trade Finance
Difference Between Letter of Credit and Guarantee
A letter of credit is a written undertaking issued by buyer’s bank to pay a certain sum of money within a stipulated period against a specified set of documents. It is a conditional undertaking. It undertakes to pay a certain amount of money on presentation of stipulated documents and the fulfillment by the exporter of all the terms and conditions incorporated in the L/C. The Letter of credit is a separate and distinct contract from the underlying sale contract, and the bank is not responsible for the fulfillment of the terms of the sale contract. The essential and basic provisions of the sale contract must be incorporated in the letter of credit. In addition, the amount of credit, its expiry date, the tenor of the draft to be drawn, party on whom the draft is to be drawn, the documents to be presented, brief description of the goods, must be Continue reading
Pre-shipment Finance
Pre-shipment is also referred as “packing credit”. It is working capital finance provided by commercial banks to the exporter prior to shipment of goods. The finance required to meet various expenses before shipment of goods is called pre-shipment finance or packing credit. DEFINITION: Financial assistance extended to the exporter from the date of receipt of the export order till the date of shipment is known as pre-shipment credit. Such finance is extended to an exporter for the purpose of procuring raw materials, processing, packing, transporting, warehousing of goods meant for exports. IMPORTANCE OF FINANCE AT PRE-SHIPMENT STAGE: To purchase raw material, and other inputs to manufacture goods. To assemble the goods in the case of merchant exporters. To store the goods in suitable warehouses till the goods are shipped. To pay for packing, marking and labelling of goods. To pay for pre-shipment inspection charges. To import or purchase from the Continue reading
Fixed-Rate Currency Swaps and Currency Coupon Swaps
Fixed-Rate Currency Swaps A fixed rate currency swap consists of the exchange between two counter-parties of fixed rate interest in one currency in return for fixed rate interest in another currency. Following are the main steps to all currency swaps: Initial Exchange for the Principal: The counter-parties exchange the principal amounts on the commencement of the swap at an agreed rate of exchange. Although this rate is usually based on the spot exchange rate, a forward rate set in advance of the swap commencement date can also be used. This initial exchange may be on a notional basis of alternatively a physical exchange. The sole importance of the initial exchange on being either on physical or notional basis, is to establish the quantum of the respective principal amounts for the purpose of (i) calculating he ongoing payments of interest and (ii) the re-exchange of principal amounts under the swap. Ongoing Continue reading
Post-Shipment Finance
Post shipment finance is provided to meet working capital requirements after the actual shipment of goods. It bridges the financial gap between the date of shipment and actual receipt of payment from overseas buyer thereof. Whereas the finance provided after shipment of goods is called post-shipment finance. DEFINITION: Credit facility extended to an exporter from the date of shipment of goods till the realization of the export proceeds is called Post-shipment Credit. IMPORTANCE OF FINANCE AT POST-SHIPMENT STAGE: To pay to agents/distributors and others for their services. To pay for publicity and advertising in the over seas markets. To pay for port authorities, customs and shipping agents charges. To pay towards export duty or tax, if any. To pay towards ECGC premium. To pay for freight and other shipping expenses. To pay towards marine insurance premium, under CIF contracts. To meet expenses in respect of after sale service. To pay Continue reading
Terms of Credit in Export Finance
The terms of credit are contractual matters of prior arrangements between buyer and seller, and their determination depends upon a number of such factors as the type of merchandise to be shipped, the availability of the merchandise, the amount involved, the market customs, the credit standing of the buyer, the country in which the consignee is located, the exchange restrictions existing in that country, the amount due from the buyer at the time the shipment is made, the availability of freight space to the country of destination, whether the account is a new one or an old one, and many other considerations. The terms of sale should be carefully distinguished from the closely related ‘terms of credits’. The terms of sale are the conditions of content, time, place and delivery of the merchandise, and only indirectly affect the extension of credit or the length of time for which credit is Continue reading