Risks and Financing in International Trade

 Risks in internaional trade

 Financing in export and import business
1. Risks in International trade
 Political Risks
❖ Politicalrisks:
- Wars, revolution, or civil unrest can lead to destruction
or confiscation of cargo.
- A government may impose severe restrictions on
export–import trade, such as limitation or control of
exports or imports, restrictions of licenses.
- Sanctions imposed against a particular country or
company.
- Imposition of exchange controls causing payments to
be blocked
 Political Risks
❖ Managing political risk
- Monitoring political developments: assess the
likelihood of political instability
https://www.credendo.com/country-risk/viet-nam
http://country.eiu.com/AllCountries.aspx (the Economist
Intelligence Unit)
https://www.euromoney.com/
Department of commerce: country risk report
- Taking insurance against political risks
 Risk of delays in payment or nonpayment could have a
crucial effect on cash flow and profit
◦ In developing countries, delays maybe due to foreign exchange
shortages ➔ central banks delays converting local currencies
into foreign exchange
 Managing Foreign Credit Risk:
- Appropriate credit management through current and reliable
information (international banks, foreign credit information
firms, government agencies…)
- Requiring confirmed, irrevocable letters of credit or other
conditions
- Insuring against credit risks
 Changes in foreign currency values could either
reduce future receipts or increase payments in
foreign currency.
 Managing Foreign Exchange Risks
- Shifting the risk to third parties
- Shifting the risk to the other party in a sale contract
❖ Shifting the risk to third parties
❖Hedging in financial markets: spot and forward
market hedge, swaps, acceleration or delay of
payments, etc.
❖Guarantees and insurance coverage
❖ Shifting the risk to the other party in an export
contract
❖Invoicing in one’s own currency
❖Invoicing in foreign currency. It is important for
the exporter to include a provision that protects the
value of its receipts from currency devaluation.
 Using Spot Market Hedge:
◦ immediate purchase or sale of currency for delivery within a short
period, typically two business days.
◦ Using the spot market to lock in the current exchange rate to avoid
future currency appreciation risks
Example:
US importer ➔ German exporter (100,000 EUR)
Sep1: contract date
(spot rate:$1.1610; forward rate: $1.1700)
Dec1: Payment due date
• Importer believes that the euro is going to appreciate ➔ buy
100,000 EUR on the spot market for $116,100 on Sep1
• On Dec 1: exchange rate was 1.1782

➔ The importer has avoided the loss of ???? `

 Using Forward Market Hedge
◦ A financial strategy where companies lock in an exchange rate
for a future date using a forward contrac to protect against
potential currency depreciation, ensuring a predictable revenue
in the exporter’s home currency
Example
US exporter ➔ Italian importer (100,000 EUR)
Sep1: contract date
(spot rate:$1.1610; forward rate: $1.1700)
Dec1: Payment due date
• Exporter believes that the euro is going to depreciate ➔ sell the
receivables of 100,000 EUR on the forward market on Sep1 and
received 117000 on Dec1
• On Dec 1: exchange rate is only $1,1500

➔ The exporter has gained??? `

• Spot hedge: Used when immediate funds are
available, typically beneficial when currency
appreciation is expected.
• Forward hedge: Preferred when payments are
due in the future, helping manage cash flow
and mitigate depreciation risks.
• how forward contracts are widely used for
managing currency risk in international trade.
• scenarios where forward hedging might be
preferred over spot hedging.
 Using Swaps
◦ A currency swap is a financial agreement between two parties to
exchange principal and interest payments in different currencies. It
is often used to manage or hedge against foreign exchange risk
◦ In international trade, firms engage in currency swaps to stabilize
costs and revenues across different currencies, avoiding losses
from fluctuating exchange rates
Example:
- A (US firm) sells goods to B (Japanese firm):

60 million yen, due Oct 1

- A purchases goods from C (Japanese firm):

60 million yen, due Dec 1

- On Oct 1: spot rate is 120 yen per dollar, Dec forward rate is 125

A sells 60 million yen ➔ 500,000USD (spot market) and purchase

60 million yen on the forward market
➔ A has made a profit of ???
 Transportation Risk
➢ Loss (partial/total) or damage to shipment during
the physical movement of goods across borders
➢ damage due to mishandling, accidents, or poor packaging
during loading, unloading, or transportation
➢ Cargo theft
➢ delayed shipments or damaged goods due to storms,
hurricanes, or rough seas
➢ delayed shipments or damaged goods due to accidents during
transport, such as vehicle or vessel collisions, derailments, or
mechanical breakdowns

➢ Managing Transportation Risk:

- Insurance is a must
-…
 Marine Insurance
Most important type of insurance in international trade.
Two essential principles:
1. The principle of insurable interest: The insured
must prove the extent of the insurable interest to
collect, and recovery is limited by the insured’s
interest at the time of loss.
2. The principle of subrogation: The insurer is
subrogated to all the rights of the insured after
having indemnified the latter for its loss.
3. There are also other 3 principles: Utmost good
faith, indemnity, fortuity not certainty
4 Types of Marine insurance:
1- Marine cargo insurance: Cargo insurance
caters specifically to the cargo of the ship and
also pertains to the belongings of a ship’s
voyagers.

2- Hull insurance: Hull insurance mainly caters

to the torso and hull of the vessel along with
all the articles and pieces of furniture in the
ship.
3- Liability Insurance: Liability insurance is that
type of marine insurance where compensation is
sought to be provided to any liability occurring
on account of a ship crashing or colliding and
any other induced attacks.
4- Freight Insurance: Freight insurance offers
and provides protection to merchant vessels’
corporations which stand a chance of losing
money in the form of freight in case the cargo is
lost due to the ship meeting with an accident.
 Types of marine insurance policy

Types of policy:
❖ Voyage policy: Policy for a single trip or shipment
❖ Time policy: Policy for a specified period
❖ Open policy: Available to exporters/importers with
larger shipments
 General average: Goods sacrificed as part of a
general average act or as a cargo owner’s contribution
for the general average loss of others.

Types of losses:
❑ Total loss: Actual total loss; constructive total loss
❑ Partial loss: General average loss, particular charges,
particular average loss.
For US-based Insurance Companies:
❖ Perils-only policy: covers extraordinary and unusual perils
that are not expected during a voyage.
❑ With average policy (WA): WA covers total as well as partial
losses. Most WA policies limit coverage to those losses that
exceed 3 percent of the value of the goods.
❑ Free of particular average policy (FPA): In addition to total
losses, partial losses from certain specified risks such as
stranding or fire are recoverable.
❖ All-risks policy: provides the broadest level of coverage
except for those expressly excluded in the policy.
Institute of Cargo Clause (ICC)
Risks Covered and the exclusions
A B C
Fire or Explosion X X X

Vessel or craft stranded, sunk, burnt or capsized X X X

Land conveyance overturned or derailed X X X
Collision or contract of vessel X X X
Discharge or Cargo at Port of Distress X X X
Earthquake, Lightning or Volcanic Eruption X X
Malicious Damage X
Theft X
General Average Sacrifice X X X
Jettison X X X
Washing Overboard X X

Entry of Sea/River or Lake water into vessel, craft, conveyance, container

or place of storage X X

Total loss of any package lost overboard or dropped whilst loading onto, or
unloading from vessel or craft X
Piracy X
 A vessel carrying a cargo of copper was stranded and part of the cargo had to be sacrificial (thrown away) to lighten
the vessel. The vessel had sustained certain damage and a salvage vessel was employed to refloat it. Adjustment of
the general average will be as follows:
 Value of the Cargo (thrown away) less duty and handling charges 10,000


 Cost of repairs for vessel

 (chargeable to general average) 40,000
 Services for salvaging vessel 35,000
 Disbursement at port and other charges 15,000
 Total “vessel” Sacrifice 90,000


 Amount to be allowed in general average 100,000

 Value of cargo (including sacrifice) 100,000

 Value of vessel (including sacrifice) 300,000

 Total Contributory Value 400,000

 Rate of general average contribution 100,000

 400,000
 Cargo’s contribution 25% (100,000) = 25,000
 Vessel’s contribution 25% (300,000) = 75,000
 Cargo owner’s liability = Assigned contribution – value of cargo sacrificed
 Thus, 25,000 – 10,000 = 15,000
 Vessel’s liability = Assigned contribution – vessel’s sacrifice
 Thus, 75,000 – 90,000 = (30,000) to receive
 Claims and Procedures
Typical claim procedures:
❖ Preliminary notice of claim: The export–import firm (insured)
must file a preliminary claim by notifying the carrier of a
potential claim as soon as the loss is known or expected.
❖ Formal notice and settlement: The consignee must file a
formal claim with the carrier and the insurance company once
the damage or loss is ascertained.
❖ Settlement of claim: If the claim is covered by the policy and
claims procedures are appropriately followed, the insurance
company will pay the insured. (if not paid => pursue
arbitration or other dispute settlement
 Basic Needs of Import/Export Financing
 Main Instruments in Export-Import Financing
 Government Programs to Help Finance
Exports
 Usually there are more formal rules in
export/import trade than purely domestic
trade
◦ Hard to get information on each party
◦ Communication is harder
◦ Customs are different
◦ Don’t want to end up in a court in a foreign country
 Shortage of capital
 Risk of Noncompletion - both the buyer and
seller do not want to be in the position of
having neither money nor goods
◦ Seller wants to have legal title to goods until getting
paid or at least assurance of payment
◦ Buyer doesn’t want to pay until receiving the goods
or receiving title to the goods.
 Transaction Exposure
 Financing
 Financing by the exporter
 Financing by the importer
 Financing by third parties
 Financing by the Exporter
❖Open account: Payment is deferred for a
specified period of time
❖Consignments: Importer pays after
merchandise is sold to a third party
❖ Advance payments: Payment is made before
shipment is effected

❖ Progress
payments: Payment is related to
performance
Short–Term Methods:
❖ Loan Secured by a foreign accounts receivable:
Account receivable used as collateral to meet short–
term financing needs

❖ Trade/banker’s acceptance: A draft accepted by the

importer is used as collateral to obtain financing

❖ Bill of lading - collateral

 An order written by exporter telling an
importer or its bank to pay a certain amount
of money now or a particular time in the
future
 Drawer issues bill - exporter
 Drawee the party to whom the draft is
addressed (if buyer - trade draft and if bank -
bank draft)
 Sight drafts are payable right away while time
drafts are payable in the future
 If drawee agrees to pay time draft - write
accepted on draft
 If drawee is a bank and draft is a time draft
then once it is accepted it becomes a
banker’s acceptance
 If an exporter needs money right away can
discount acceptance
 Banker’s acceptances are instruments that
investors hold to earn extra short-term
income
 Issued by common carrier to exporter
 Three main purposes:
◦ 1) receipt (carrier has received merchandise)
◦ 2) contract (lists responsibilities of carrier)
◦ 3) document of title (used to obtain payment or
promise of payment before goods are released
to importer)
 Can function as collateral so exporter can
get money by its local bank prior to
receiving it from importer
❖ Letter
of credit: Transferable letter of credit (L/C),
assignment of proceeds under an L/C, and a back–to–
back L/C used to secure financing

❖ Factoring: An arrangement between a factoring concern

and exporter whereby the factor purchases export
receivables for a discount
 Issued by a bank at the request of an
importer
 The bank promises to pay a beneficiary
(usually the exporter or the exporter’s bank)
after receiving certain documents specified in
the Letter of Credit
 The bank puts itself in the middle
between the buyer and the seller

 Exporter likes it because it reduces the

risk of noncompletion. Even if there are
foreign exchange blockages the exporter
is more likely to get paid since banks
have more access to foreign exchange
than most companies.
 Exporter may also get pre-export financing
easier
 Importer will often not have to pay until the
bank receives the proper documents and all
conditions stated in the LC have been
satisfied.
 Disadvantage – Cost to the importer
Transferable letter of credit:
Exporter transfers its rights under the credit to
another party, usually a supplier, who receives
payment. When the supplier presents the
necessary documents to the advising bank, the
advising bank pays the supplier the value of
the invoice and will pay the difference to the
exporter.
Assignment of proceeds under the letter of
credit:
The beneficiary (exporter) may assign either
the entire amount or a percentage of the
proceeds of the L/C to a specified third party,
usually a supplier. This allows the exporter to
make purchases with limited capital by using
the overseas buyer’s credit. It does not require
the assent of the buyer or the buyer’s bank.
Back-to-back letters of credit: A letter of credit
is issued on the strength of another letter of
credit. Such credits are issued when a supplier
or subcontractor demands payment from the
exporter before collections are received from
the customer. The exporter remains obligated
to perform under the original credit, and if
default occurs, the bank is left holding a
worthless collateral.
❖ Factoring: An arrangement between a factoring
concern and exporter whereby the factor purchases
export receivables for a discount
◦ Factoring is a form of credit granting by commercial banks to
exporters through the purchase of the receivables arising from the
goods purchase and sale as agreed by the exporters and importers
in foreign trade agreements.
◦ Export factoring services:
◦ Insurance of Importer’s Credit Risks.
◦ Maintenance of receivables.
◦ Advance payment of up to 90% of the value of receivables.
◦ Debt recovery.
  1. 1. Commercial contract
Exporter 2. Goods
Importer

6. Presentation
4. $ 3. Invoice Of Invoice 7. $ on due date

5. Invoice Import
Export Factor 8. $ Factor
 Intermediate- and Long-Term Methods

❖ Buyer credit: Importer obtains a credit from a

bank or financial institution to pay the exporter
❖ Forfaiting: Purchase of deferred debts arising
from international sales contracts without
recourse to the exporter
❖ Export leasing: A firm purchases and exports
capital equipment with a view to leasing
 Factors are often used to finance consumer goods,
whereas forfaiters usually work with capital goods,
commodities, and projects.

 Factors are used for continuous transactions, but

forfaiters finance one–time deals.
 Forfaiters work with receivables from developing
countries whenever they obtain an acceptable bank
guarantor; factors do not finance trade with most
developing countries because of unavailability of
credit information, poor credit ratings or inadequate
legal and financial frameworks.

 Factors generally work with short–term receivables,

whereas forfaiters finance receivables with a maturity
of over 180 days. (See Table 13.3 for advantages and
disadvantages of this financing method.)
 Factoring vs. Forfaiting
Criteria Factoring Forfaiting

Goods Covered Consumer goods Capital goods, projects, etc.

Medium to long-term (over

Duration Short-term
180 days)

No waiver of recourse to the Waiver of recourse to the

Recourse to Exporter exporter, resulting in low exporter, resulting in high
credit risk coverage credit risk coverage

Low discount rate (around

High discount rate (around
Discount Rate 100%) but with higher fees
80%)
and interest rates

No, due to lack of credit

Payment Guarantee for information, low credit Yes, if there is a bank
Receivables from Developing ratings, and insufficient guarantee to support the
Countries policy/financial mechanisms transaction
in developing countries
 In Vietnam
- Providing loans for contracts on export/import of
Vietnamese goods which directly recover capital and
prove their effectiveness and solvency.
- To get loans, export and import contracts must have
financial plans and loan repayment plans appraised by the
Vietnam Development Bank.
- Loan-taking exporters and overseas importers must
fullfil all contractual commitments and regulations of
Decree No.75/2011/ND-CP dated 30 August 2011.
- The government issued the list of goods eligible for
export credit.
 Exporters often get business because they
offer more favorable credit terms than their
competitors
 Export credit insurance allows companies to
offer favorable credit terms because in cases
of default the insurance companies will pay a
substantial part of the loss
 If the exporter has export credit insurance,
the importer may not need a letter of credit
which will save the importer money
 Insurance against
◦ commercial risk (insolvency or lack of payment of
buyer)
◦ political risk (actions of governments beyond
control of buyer or seller)
 examples- buyer can’t get dollars or approved
currencies and transfer them to the insured, civil war,
or importer can’t import goods
 Goods and services are paid for or partially
paid for by other goods and services
 Often one country involved may be less
developed, a centrally planned economy, has
more political risk, and/or has poor quality
goods
 Countertrade is often a second best solution
(free trade is best)
 Examples include
◦ simple barter (goods for goods - Pepsi for vodka)
◦ buyback or compensation agreement (export plant
and equipment and get paid in output of new firm -
build a car plant and get paid in cars)