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The Handbook of International Trade and Finance: The Complete Guide to Risk Management, International Payments and Currency Management, Bonds and Guar

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For anyone involved in international sales, finance, shipping and administration, or for those studying for academic or professional qualifications in international trade, The Handbook of International Trade & Finance offers an extensive and topical explanation of the key finance areas - including risk management, international payments and currency management. This essential reference resource provides the information necessary to help you to reduce risks and improve cash flow, identify the most competitive finance alternatives, structure the best payment terms, and minimize finance and transaction costs. This fully revised and updated 3rd edition also describes the negotiating process from the perspectives of both the buyer and the seller, providing valuable insight into the complete financing process, and covering key topics such as: - trade risks and risk assessment - export credit insurance - methods of payment - trade finance - bonds, guarantees and standby letters of credit - terms of payment - currency risk managementThe Handbook gives a complete and thorough assessment of all the issues involved in constructing, financing and completing a cross-border transaction and is an indispensable guide for anyone who deals with international trade.

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01 Trade risks and risk assessment

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Trade risks and risk assessment

International trade practices

All forms of business contain elements of risk, but when it comes to international trade, the risk profile enters a new dimension. Internationally, you seldom have common laws that can support the transaction, as would be the case within one country. Instead, established trade practices and conventions are used to settle the undertakings made by the parties. The main sources for international trade practices are publications issued by the International Chamber of Commerce (ICC), which will be referred to many times throughout this book.

Successful trade transactions, therefore, depend on a knowledge of these established practices and ensuring that the undertakings in the individual contract are in line with such practices. This is why it is crucial for the seller to have started with a correct risk assessment before entering into the transaction. Sometimes, however, the circumstances in a particular case are so obvious that one hardly thinks of it as a risk assessment, whereas in other situations a thorough risk assessment needs to be done.

 

02 Methods of payment

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Methods of payment

Different methods of payment

The method of payment determines how payment is going to be made, ie the obligations that rest with both buyer and seller in relation to monetary settlement. However, the method of payment also determines directly or indirectly the role the banks will have in that settlement.

Methods of payment and terms of payment

These two expressions are sometimes used synonymously, but in this book they have been kept separate.

Methods of payment represents the defined form of how the payment shall be made, ie on open account payment terms through a bank transfer, or through documentary collection or letter of credit.

Terms of payment defines the detailed obligations of both commercial parties in relation to the payment, not only the form of payment and when and where this payment shall be made by the buyer, but also the obligations of the seller: to deliver according to the contract and, for example, to arrange stipulated guarantees or other undertakings prior to or after delivery.

 

03 Bonds, guarantees and standby letters of credit

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Bonds, guarantees and standby letters of credit

The use of bonds and guarantees

In international trade it has become increasingly common for either or both parties to demand separate undertakings, usually in the form of bonds, guarantees or standby letters of credit, covering the obligations assumed by the other party.

It could be the sellers delivery obligations that have to be secured by a guarantee issued by their bank, or the seller receiving a guarantee covering the payment obligations of the buyer. In any case, this undertaking is often the glue that holds a deal together, a deal that might not otherwise materialize owing to the inherent latent risks involved. This is most common for transactions that, apart from delivery, also cover installation, future performance, warranty periods or similar undertakings, when the parties are mutually dependent on each other, often for a long period.

In certain cases, particularly with more straightforward deals or in combination with a simple service and/or performance, it is often enough that the seller, or the parent or group/company, issues these bonds/guarantees particularly if the seller is part of a larger or well-known group. However, in most cases, they have to be issued by a separate party, normally in the form of a bank guarantee or an insurance bond (from an insurance company) or as a standby L/C (issued by a bank).

 

04 Currency risk management

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Currency risk management

Currency risk

Since the early 1970s, when the system of fixed currency rates finally collapsed, exchange rates between most countries have more or less floated. The possibility of coordinating alternative exchange systems along with the political ambition to do so has decreased over time, based on the realization that currency cooperation, in any meaningful sense, depends on close economic and financial cooperation.

Against this background most countries have chosen to deal with the relation between their own and other currencies and the corresponding currency exchange mechanism in their own way. The most common ways include:

Pegging directly to other currencies may be a risky business in the long run if the underlying economic development is different between the countries involved, and could trigger sudden currency disturbances when the pegging collapses or is mistrusted by the markets. Such events could be dramatic, not only as a potential currency risk, but also because they can disturb the entire trade system and the whole economy of the country.

 

05 Export credit insurance

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Export credit insurance

A mutual undertaking

Previous chapters have dealt with the different forms of risk that can occur in an international trade transaction, risks that have to be covered through the terms of payment. But, in many cases, that may be difficult to achieve, because the buyer does not accept the proposed terms, the bank is unwilling to take the risks involved, or the remaining risks may be considered by the seller as being too high.

The terms of payment must be negotiated in the same way as other parts of the contract, in which both commercial parties often have to make a compromise. In many countries there are established practices in the way payments are made and it may be difficult to agree with the buyer should the terms differ too greatly from these practices particularly if they expect other suppliers to offer more competitive terms. In other situations, the seller may have difficulty in finding financial institutions that are willing to accept the inherent risks in the discussed terms of payment, in particular related to the political and/or commercial risks in many countries in conjunction with short-term financing, not to mention medium- or long-term periods.

 

06 Trade finance

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Trade finance

Financial alternatives

Being able to give or to arrange finance as part of an export transaction is increasingly important, both as a sales argument and to meet competition from other suppliers. This applies particularly in the case of heavier capital goods or whole projects, where finance is often an integrated part of the package, but it may also apply to raw materials, consumer goods and lighter capital goods for shorter periods.

The length of credit is often divided into short, medium and long term, even though such classifications are arbitrary and depend on the purpose. Short-term credits are normally for periods up to one year, even though the typical manufacturing exporter would normally trade on short-term credits of 60 or 90 days, perhaps up to a maximum of 180 days. Periods between one and two years may be described as both short- and medium-term depending on the purpose, whereas periods from two to five years are medium-term and periods above that are long-term credits.

 

07 Structured trade finance

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Structured trade finance

The expression structured trade finance is used in many different situations and is not generally defined. In this book it has the meaning of prearranged or tailor-made trade financial techniques or structures, designed for individual transactions or projects, arranged by, or in cooperation with, specialized financial institutions.

International leasing

Leasing in its simplest form is a means of delivering finance, broadly defined as a contract between two parties where one party (the lessor) provides an asset, mostly equipment, for usage to another party (the lessee) for a specified period of time, in return for specified payments.

Leasing is a medium-term form of finance for machinery, vehicles and equipment, with the legal right to use the goods for a defined period of time but without owning or having title to them. The lease is normally divided into two separate categories:

The distinction between these types of lease is not always that clear in reality and many leases are frequently structured in one way while being defined in another, usually owing to potential cost or tax advantages. However, in most countries where leasing is frequently used, such as the United States, tax authorities or the domestic Accounting Standards Board has laid down specified conditions for a lease to be classified as an operational lease.

 

08 Terms of payment

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Terms of payment

Terms of payment and cash management

Through the terms of payment, the objective of both parties is to optimize the outcome and profitability of the transaction within the framework of an established and acceptable risk level. However, from the sellers perspective, the terms of payment can also be used as an additional sales argument to strengthen their competitive edge, in the same way as other parts of the contract. This makes it important to understand the structure of terms of payment and how they could be used in conjunction with guarantees, different forms of finance solutions and separate export credit insurance. Such a framework also raises the question of how to use the capital resources in the most efficient way. Anyone who controls these matters will be a better negotiator and able to conduct more profitable business.

In most cases, effective cash management means minimizing the use of capital while at the same time using the resources available to support the core business of the company. Good cash management could, for example, involve the seller offering the buyer a medium-term supplier credit in order to be more competitive, providing the risk is curtailed and that such credit is deemed to be necessary to get the deal.

 

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