Risks in International Trade

Risks in International Trade Both sides face risks in an export transaction. This is because there is always the possibility that the other side may not fulfil the contract. For the exporters there is the risk of buyer default; the customers might not pay in full for the goods. There are several possible reasons for this: the . importers might go bankrupt; a war might start or the importers' government might decide to ban trade with the exporting country; or they might ban imports

of certain commodities. Another possibility is that the importers might run into difficulties getting the foreign exchange to pay for the goods. It is even possible that the importers are not reliable and simply refuse to pay the agreed i amount of money. For the importers there is the risk that the goods will be delayed and they might only receive them a long time after paying for them. This may be caused by port congestion or strikes.

Delays in fulfilment of orders by exporters and difficult Customs clearance in the importing country can cause loss of business. There is also a risk that the wrong goods might be sent. It is to guard against such possibilities that different methods of payment have been developed. B The Banks and Problems of Payment Many of the risks in foreign trade are reduced by the work of the

banks. They provide several services which give security to exporters and importers. The risk of buyer default or non-delivery by exporters is removed by the method of payment against shipping documents. Also exporters' banks provide information about the financial reliability of their customers. They also help arrange buyer credit or finance for the sellers. Without this a lot of trade would not take place at all.

There is also a risk of financial loss because of a change in the exchange rate. If an Indian exporter agreed to sell goods for dollars and the value of the dollar in terms of rupees went down, the exporter would get fewer rupees for the dollars. Conversely, if the price of the dollar went up, the importers would lose money. An Arabian importer would have to pay more rials to buy the dollars.

This kind of loss can happen in any export-import situation where the national currencies go up and down in terms of the payment currency, whether it is Deutschmarks, sterling, yen or francs. But the risk can be avoided, with the help of a bank, by buying the foreign exchange on the forward exchange market. An exporter who is due to receive dollars arranges to sell them at a price fixed in the present but

for delivery in two or three months. The time for delivery of the dollars depends on the length of credit given to the importers. At the same time the importers can arrange to buy dollars forward. In each case the traders pay a premium, but they can base their calculations on fixed exchange rates and avoid uncertainty and risk of loss. C Methods of Payment There are three basic methods of payment in foreign trade but traders usually use the one which

is customary in their business. 1 Payment against documents. The shipping documents are exchanged with the bank representing the importers. There are two procedures: Documentary Bills and Documentary Letters of Credit. The latter is the commonest method of payment. 2 Payment into an open account. This is used where there is complete trust between seller and buyer.

Also there must be no political or currency problems. The exporters simply airmail the shipping documents to the importers who settle their account monthly or quarterly. 3 Cash in advance. This is used only for small orders sent by parcel post. Whatever method is used, the sellers have to check the credit status (financial strength) of the buyers. Also in cases of very big contracts, government finance is used.

D Foreign Bills of Exchange A lot of foreign trade is paid for using Bills of Exchange so it is necessary to understand what a Bill of Exchange (see page 89) is. Basically it is a credit instrument or a piece of paper which can be turned into money later. The exporters write a draft to the importers. The draft is a note, like the one shown opposite, telling them to pay a certain amount of money to

a third party. The exporters are the drawers of the draft, the importers, the drawees and the third party to whom the draft should be paid, the payees. The drawees agree to pay the draft at the time when it becomes due, that is say, 120 days after sight and the draft has to be accepted by being signed. But if a company of importers accepted the draft with their

Signature on the back, it would not have much value, because their name and the state of their finances might not be valued highly. So the draft has to be accepted by a well-known bank representing the importers. This turns the draft into a Bill of Exchange which is sent to the payees, who are either the exporters or their bank. The payees know by the signature of the bank on the back, that the Bill will in fact be paid at maturity (60, 120 or 180 days after sight, the day the draft was accepted).

E Discounting Bills of Exchange Following from the last passage, the situation is as follows; the importers do not have to pay for their goods yet. They have credit until the Bill matures. On the other hand the exporters have the Bill of Exchange and no money. But they need money to pay their costs, so how does the Bill help them? The answer lies in the fact that Bills of

Exchange are negotiable instruments and can be sold on the discount market. This is a market in which buyers and sellers, mainly banks, trade in Bills for profit. It works as follows: The buyer pays the amount of the Bill less the discount. This is the amount of interest for the period the Bill has to run until maturity. If the period is 90 days, the interest deducted is 1/4 the current rate

of interest for that kind of commercial Bill times the face value of the Bill. If the interest is 10% and the Bill worth Ј100 the discount for 90 days would be 1/4 * 10% * 100 ==Ј2.50 because 90 days is 1/4 of a year and interest rates are always given for the year. Therefore the exporter would get Ј100—Ј2.50 for the Bill. Naturally, this is less than the importers have to pay after 90 days, so exporters have to allow

for interest when calculating their export prices and when they are giving credit. But how does the buyer of the Bill make a profit? The discount for the Bill gets less and less as time goes on. Also, interest rates change. So the holder of the Bill can sell it again to another buyer, this time getting more than the amount he paid.

If the period left until maturity was 30 days the interest would be for one month only. At 10% the discount would be Ј0.83 so the seller would get Ј99.17 for the Bill. F Payment by Documentary Bills This is one of the simplest methods of payment. The exporters put together the following: 1 Bills for Collection form {see page 94) or remittance letter.

2 Draft drawn on the importers for the amount of money of the contract. 3 All the shipping documents. These are airmailed to a bank in the importers' country which has the task of collecting payment from the importers. Payment can be either immediate or after a period of time. If the terms of the contract are D/P{documents against payment) the exporters draw a sight draft. This means the collecting bank gets immediate payment from the importers when it presents the shipping

documents to them. If, on the other hand, the exporters have agreed to give credit they use D/A terms (documents against acceptance). This means they draw a time draft which has to be accepted by another bank acting for the importers. The draft might be drawn 90 or 180 days after sight so the importers' bank has to pay the collecting bank three or six months after the day they receive the draft. An accepted draft is sometimes called a usance Bill.

The collecting bank charges the exporters for its services and the accepting bank charges the importers for signing acceptance of the draft (now a usance Bill of Exchange). The exporters have to give instructions to the collecting bank (Section 7 of the form) what to do in case the importers dishonour the draft (i.e. refuse to accept or pay it). The collecting bank may protest the Bill. This means that banks and other companies dealing with them

are informed about the dishonouring of the draft. (Note 3 at the bottom of the collection form advises the exporters to endorse the Bills of Lading in blank (see page 94), This means they can only write the name of the agent on the Bill of Lading in case the importers dishonour the draft. The goods can then be sold to somebody else or returned to the exporters.)

G Documentary Letters of Credit A documentary Letter of Credit is an agreement with banks, made by an importer, to pay an exporter, provided certain conditions are fulfilled. The importers apply to their bank to issue the credit in favour of their suppliers through a bank in the suppliers' country. If the importers wish to guarantee payment of the credit they ask their bank to issue an irrevocable credit. This means the credit cannot be exchanged without the exporters'

and banks' agreement. A credit without such a guarantee is a revocable credit and can be changed by the importer. If, in addition, the importers want the advising bank in the sellers' country to guarantee the credit, they will request confirmation by the advising bank. The credit then becomes a confirmed irrevocable credit (see page 97). From the point of view of the exporters (the beneficiaries) this is the safest form of credit to have.

There are three kinds of credit payment. 1 A credit for payments of drafts is when D/P terms have been agreed and an advising bank pays drafts drawn by the exporters, or their bank, on itself, at sight. 2 An acceptance credit is when D/A terms have been agreed and the advising bank or another bank accepts drafts for payment after a period of time, e.g. 120 days after sight. 3 A credit with authorities to negotiate is when the confirming or issuing bank

may make a bargain with the exporters for acceptance of a draft drawn in another currency. Whichever form of credit is used, however, the bank where the Credit is available will only pay the exporters when all the shipping documents are correct according to the terms of the credit.