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American companies marketing products and services overseas are finding that it improves their competitive edge to be able to quote prices and accept payments in foreign currencies. Selling in the customer's currency may put a U.S. supplier on equal footing with local and sophisticated multinational competitors and help keep prices from fluctuating. Selling overseas introduces two categories of risk beyond problems resulting from governmental interference in international transactions whether in U.S. dollars or foreign currency. Exchange rate risk occurs when sales are denominated in currencies other than the seller's. What will the currency be worth when it is received and converted into dollars?
Governments can affect the local exchange market by restricting access to foreign currency, limiting the forward market, and limiting international payments to certain types of transactions. This is commonly known as convertibility risk and can be difficult to control. Credit managers must gauge the impact of current restrictions and the probability of new ones being imposed. Among the questions to ask are:
* What restrictions does the coun5r have?
* What impact have previous government policies had?
* Is the country liberalizing exchange and payment restrictions?
While most industrial countries have few restrictions, in times of crisis such as the one experienced by the European Rate Mechanism (ERM) last year, temporary illiquidity and official restrictions can occur in the exchange markets, causing difficulty in effecting payments and entering into foreign exchange hedge contracts.
FORWARD CONTRACTS KEEP CASH FLOWING
The risk of adverse rate movements on non-U.S. dollar receivables or payables is a type of transaction risk which can be hedged using forward foreign exchange or foreign currenc option contracts. A forward contract is a mutually binding agreement bctween two parties to exchange a cerain amount of...