Question

2. Explain the various export payment terms available, which offers the most protection to the seller. Why is an exporter that is to be paid in six months in foreign currency worried about fluctuating exchange rates. Are there ways that this exporter can protect itself?

Answer 1

There are five types of payment method available to the exporter, they are: consignment, open account, documentary collections, letter of credit (L/C), Cash in advance. ( In the order of least secure to most secure)

Consignment: It is the variation of open account as most risk is assumed by the seller. Here exporter does not receive payment until the importer receive the goods. As there's third party generally one who is shipping the good is involved in having an insurance helps reduce risk from exporter side. The product stays with the importer until terms of the sell is met.

Open Account: It is the system where exporter i.e. seller assumes all the risk related to trade, provided customer or buyer (importer) is reliable and trustworthy.

Documentary collection: Here exporter ships the goods and draw a bill of exchange importer through an intermediary bank. This draft is an order for payment if terms and conditions of the sale are met. This help reduces the risk to the great extent. This method is generally used when cash in advance or open account method is not acceptable to the buyer or seller respectively.

L/C: A LC is a document issued by a bank at the buyer’s request in favor of the seller. It act as guarantee of payment to the seller if all the terms and conditions of the sales are met.

Cash in Advance: This method is a most secure method for the exporter. As the buyer sells his product after receiving money from the buyer.

In the International trade market, currency generally fluctuates as the demand or supply of one quantity increase or decreases. Hence exporter worries that, if he's receiving the money after 6 months and by that time his home currency appreciate, he may not get the required money after the exchange. For example, today his currency going for 100 and he is expecting the revenue of 1000 by selling 10 units. But he's going to receive the money after 6 months and by that time his currency appreciate to 50 and revenue is 500 only. Thus he suffered the loss of 500.

Hence exporters are worried about the fluctuation of currency in the international market.

An exporter can protect oneself against this volatility by hedging currency in future or forward market. This type of hedging will protect the exporter against the volatility of the currency in the market.