Risks in International Trading
In understanding the problems of Buyers and Sellers in International Trade it is important to appreciate some of the risks that they face in the normal course of their business.
All business of course carries some element of risk, but international traders have to deal with particular problems and learn to take appropriate precautions to limit their exposure if they wish to safeguard their businesses and to prosper.
These will include not only the hazards of handling and transporting goods over long distances to remote locations, but unforeseen fluctuations in transport costs and currencies.
Foreign Exchange Fluctuations: In any international trade transaction either the buyer or the seller, and sometimes both, will also be involved in a foreign exchange transaction, buying or selling the currency used in payment for the goods or services. This presents the problem that rates of exchange fluctuate and, therefore, the price set when the sales contract was made may not be directly reflected in the money actually received by the seller or paid by the buyer.
To take a simple example, if the price set for a consignment of goods sent to the USA by a UK exporter was $60,000 calculated at an exchange rate of $1.50 to the £, the exporter would expect to receive £40,000 when he changed the dollars at the bank. If, however, by the time payment was actually made and he changed the Dollars into Pounds the rate had altered to $2.00 to the £, the exporter would only receive £30,000 which would quite likely turn his anticipated profit on the sale into a loss.
International traders have a number of alternatives to consider when facing the possibility of currency fluctuations working against them.
After assessing the risks they could of course decide to do nothing – to take a chance that the fluctuation, if it is unfavorable, will not be so serious as to put the business in peril. In this case they will either buy or sell their currency on the spot market at the time of the transaction. If they are lucky and the exchange rates move in their favor they can take advantage of an unexpected bonus.
However, for those traders dealing in large amounts of currency or working on small margins this may be an unacceptable risk. In this situation, banks can offer a number of alternatives for Hedging Against Currency Losses, such as Forward Exchange Contracts or Foreign Currency Options.
Many companies adopt a combination of these methods in order to spread their risk and keep down the costs. One method of reducing the effect of exchange rate fluctuations and the uncertainty they create for both buyer and seller is for them to enter into a contract with their bank to buy or sell foreign currency at a future date but at a rate fixed at the time of the contract.