Topic 7 - Foreign Trade Risk and Coverage Flashcards
Define ‘exchange rate risk.’
Risk associated with an increase or decrease of the exchange rate in the time period between the contract is signed and payment is received, in international trade sales.
Define ‘exchange rate insurance.’
Contract between an exporter and a financial entity (commercial bank) whereby the exchange rate is fixed for a period of time (forward exchange rate).
State the ‘Exchange rate insurance’ characteristics.
- Can be contracted for all or part of the commercial operation.
- Can be agreed in any moment between the starting date of the contract and the date of the payment.
- Forward quotes are calculated by banks (and are calculated using the difference between the interest rates of the currencies involved in the contract).
- A bank commission or fee is paid.
Name the 4 export payment and insurance cancellation processes.
- Payment at agreed time
- Advance payment
- Delayed payment
- Non-payment
Describe ‘Payment at agreed time.’
Once the payment is received, the forward/insurance contract is cancelled.
Describe ‘Advance payment.’
The exporter has 3 options:
• Negotiate the anticipated cancellation of the insurance.
• Put the currency in a paid interest deposit for the days up to the deadline.
• Sell the currency in the spot currency market if the exchange rate is favourable (although this has some risk) and buy the currency again on the deadline to cancel the insurance contract.
Describe ‘Delayed payment.’
If the exporter is certain that is going to be paid:
• Negotiate an extension of the insurance.
• Buy the currency in the spot currency market if the exchange rate is favourable (although this has some risk) and cancel the insurance contract, and sell the currency again when the payment arrives.
Describe ‘Non-payment.’
The exporter will have to buy the currency in the spot currency market and cancel the insurance contract.
Define ‘options on foreign currency.’
Right to buy or sell a foreign currency at a previously established rate in a given date in the future.
- Call option (buy a currency)→ importer
- Put option (sell a currency) → exporter
State the characteristics of ‘options on foreign currency.’
The exporter (or importer) firm negotiates and fixes an exchange rate with the bank at which the firm wishes to buy (or sell) a currency on a given date (strike price). - A premium is paid at the time of purchasing the option, and the amount paid is based on the exchange rate determined. (In insurance/forward contract, a bank commission or fee is paid instead.)
Describe the ‘risk of order cancellation’ characteristics.
- May occur since the exporter receives a firm order until shipment of the goods.
- If there is a cancellation, there might be some costs, related to goods already produced or in the process of production.
- The extent of the costs depend on how specific are the goods produced.
State the coverage methods of ‘risk of order cancellation.’
- Advanced payment
- Guarantee of compliance
- Letter credit
- Insurance policy
Describe the characteristics of ‘non-payment risk.’
- The risk that the importer collects the goods and doesn’t pay for them.
- Non-payment of the importer could be due to a certain legal situation (bankruptcy) or simply acting in bad faith.
State the coverage methods of ‘non-payment risk.’
- Letter of credit
- Documentary payment order
- Insurance policy
- Factoring
Describe the ‘political risk’ characteristics.
When the political or economic circumstances of the destination country prevent the punctual completion of payments or the correct completion of contracts
For example, when a country freezes payments to foreign counties, usually imposed as a consequence of a persistent deficit in the balance of payments
