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?Article Assignments: This assignment is a review/analysis and critique of an article. The article chosen may be selected from the two most recent issues of magazines selected. The assignments are to include an one paragraph summary of the article and at least a paragraph analyzing how the issues of the article relate to the material of the day. Attention: The length of the critique has to be at least the same length as the summary.????

Now You ARE READY FOR THE STEPS NEEDED TO COMPLETE AN import or
export transaction. In Chapter 2 you learned the basics of start-up. Chapter 3 led you
through the concepts of planning and negotiating a transaction. Chapter 4 explained how to
compete in the Internet marketplace. This chapter covers the four remaining
commonalities, which encompass paying for the goods and physically moving them from
one country to another.

1. Finance your import/export transaction.

2. Avoid risk.

3. Pack and ship your product (physical distribution).

4. Supply all documentation.

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FINANCING

Why do you need financing in the import/export business?

To start, expand, or take advantage of opportunities, all businesses need new money
sooner or later. New money means money that you have not yet earned, but that can become
the engine for growth.

For the importer, financing offers the ability to pay for the overseas manufacture and
shipment of foreign goods destined for the domestic market. For the exporter, financing
means working capital to pay for international travel and the marketing effort. New money
can also be loans to foreign buyers to enable them to purchase an exporter’s goods.

If you have done the homework phase well and have purchase orders for your
product(s) in hand, there is plenty of currency available-banks or factors are waiting to assist
you.

The Bank

Commercial banking is the primary industry that supports the financing of importing and
exporting. Selection of a banking partner is an essential part of the teamwork required for
international trade success. When shopping for a bank, look for the following:

1. A strong international department.

2. Speed in handling transactions. (Does the bank want to make money on your money-
called the float?)

3. Relationship with overseas banks. (Does the bank have corresponding relationships
with banks in the countries in which you wish to do business?)

4. Credit policy.

HOT TIP: In the import/export industry there is a saying: “Walk on two legs.” This means
choose carefully, then work closely with a good international bank and a customs broker or
freight forwarder

Forms of Bank Financing

Loans for international trade fall into two categories: secured and unsecured.

Secured Financing

Banks are not high risk takers. To reduce their exposure to loss, they often ask for
collateral. Financing against collateral is called secured financing and is the most common
method of raising new money. Banks will advance funds against payment obligations,
shipment documents, or stor age documents. The most common method is advancement of
funds against payment obligations or documentary title. In this case, the trader pledges the

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goods for export or import as collateral for a loan to finance them. The bank maintains a
secure position by accepting as collateral documents that convey title, such as negotiable
bills of lading, warehouse receipts, or trust receipts.

How a Banker’s Acceptance Works

Another popular method of obtaining secured financing is the banker’s acceptance (B/A).
This is a time draft presented to a bank by an exporter. (It differs from a trade acceptance
between buyer and seller, in which a bank is not involved.) The bank stamps and signs the
draft “accepted” on behalf of its client, the importer. By accepting the draft, the bank
undertakes and recognizes the obligation to pay the draft at maturity, and has placed its
creditworthiness between the exporter (drawer) and the importer (drawee). Banker’s
acceptances are negotiable instruments that can be sold in the money market. The B/A rate
is a discount rate generally 2 to 3 points below the prime rate. With the full
creditworthiness of the bank behind the draft, eligible B/As attract the very best of market
interest rates. There are specific criteria for eligibility.

1. The B/A must be created within 30 days of the shipment of the goods.

2. The maximum tenor is 180 days after shipment.

3. The B/A must be self-liquidating.

4. The B/A cannot be used for working capital purposes.

5. The credit recipient must attest to no duplication.

Shipping documents: Commercial invoices, bills of lading, insurance certificates, consular
invoices, and related documents. Draft: The same as a “bill of exchange.” A written order for
a certain sum of money to be transferred on a certain date from the person who owes the
money or agrees to make the payment (the drawee) to the creditor to whom the money is
owed (the drawer of the draft).

Unsecured Financing

In truth, unsecured financing is only for those who have a sound credit standing with their
bank or have had long-term trading experience. It usually amounts to expanding already
existing lines of working credit. For the small import/export business, unsecured financing
will probably be limited to a personal line of credit.

Factors

A factor is an agent who will, at a discount (usually 5 to 8 percent of the gross), buy
receivables. Banks do 95 percent of factoring; the remainder is done by private specialists.
The factor makes a profit on the collection and provides a source of cash flow for the seller,
albeit less than if the business had held out to make the collection itself.

For example, suppose you had a receivable of $1000. A factor might offer you a $750
advance on the invoice and charge you 5 percent on the gross of $1000 per month until

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collection. If the collection is made within the first month, the factor would keep only $50
and return $200. If it takes two months, the factor would keep $100 and return only $150.

The importer benefits from having the cash to reorder products from overseas. For a
manufacturer, the benefit can be cash flow available for increased or new production.

Other Private Sources of Financing

The United States has several major private trade financing institutions, all in competition
to support your export programs.

PEFCO. The Private Export Funding Corporation (PEFCO) was established in 1970 and
is owned by about 60 banks, 7 industrial corporations, and an investment banking firm.
PEFCO operates with its own capital stock, an extensive line of credit from the U.S.
government’s EXIMBank (see below), and the proceeds of its secured and unsecured debt
obligations. It provides medium-and long-term loans, subject to EXIMBank approval, to
foreign buyers of U.S. goods and services. PEFCO generally deals in sales of capital goods
with a minimum commitment of about $1 million-there is no maximum. Contact: PEFCO,
280 Park Avenue (4-West), New York, NY 10017; phone: (212) 916-0300; fax: (212)
2860304; Web: www.pefco.com.

OPIC. The Overseas Private Investment Corporation (OPIC) is a private, self-sustaining
institution whose purpose is to promote economic growth in developing countries. OPIC’s
programs include insurance, finance, missions, contractors’ and exporters’ insurance, small
contractor guarantees, and investor information services. For more information, contact:
OPIC, 1615 M Street, NW, Washington, DC 20527; phone: (202) 336-8400; fax: (202) 408-
9859; Web: www.opic.gov.

Government Sources

Many nations are short on foreign exchange, and what they have is earmarked for priority
national imports or large international credit commitments. Nevertheless, there are
probably more sources of competitive financing available today to support exporting than
at any other time in history. The major complaint is that not enough firms are taking
advantage of the programs.

Small Business Administration (SBA). All nations support the growth of small business.
For example, the U.S. government’s Small Business Administration (SBA) guarantees eight-
year working capital loans for about 2.25 percent over prime to small companies that can
show reasonable ability to pay. The maximum maturity may be up to 25 years, depending on
the use of the loan proceeds. The SBA’s export revolving-line-of-credit guarantee program
provides pre-export financing to aid in the manufacture or purchase of goods for sale to
foreign markets and to help a small business penetrate or develop a foreign market. The
maximum maturity for this financing is 18 months. The SBA, in cooperation with
EXIMBank, participates in loans between $200,000 and $1 million.

EXIMBank. When U.S. exporters find buyers who cannot obtain financing in their own
country, the Export-Import Bank of the United States (EXIMBank) may provide credit
support in the form of loans, guarantees, and insurance for small businesses. EXIMBank is a

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federal agency to help finance the export of U.S. goods and services. Rates vary but are
available for a 5-to 10-year maturity period.

Programs include medium-and long-term loans and guarantees that cover up to 85
percent of a transaction’s export value, with repayment terms of a year or longer. Long-term
loans and guarantees are provided for over 7 years but not usually more than 10 years. The
Medium-Term Credit Program has more than $300 million available for small businesses
facing subsidized foreign competition. The Small Business Credit Program also has funds
available, with direct credit for exporting medium-term goods; competition is not necessary.
The EXIM Working Capital Program guarantees the lender’s repayment on capital loans for
exports.

Agency for International Development (AID). A subordinate division of the U.S. State
Department, AID provides loans and grants to nations for both developmental and foreign
policy reasons. Under the AID Development Assistance Program funds are available at rates
of 2 percent and 3 percent over 40 years. The AID Economic Development Fund has funds
at similar interest rates. Generally, these funds are available through invitations to bid placed
in the Commerce Daily Bulletin, a publication-available from the Government Printing
Office, Washington, DC 20402.

International Development Cooperation Agency (IDCA). The IDCA Trade and
Development Program loans funds on an annual basis to enable friendly countries to procure
foreign goods and services for major development projects. Often, these funds support
smaller firms in subcontract positions.

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AVOIDING RISK

Doing business always involves some risk, so you should expect across-border business to
be no different. A certain amount of uncertainty is always present in doing business across
international borders, but much of it can be hedged, managed, and controlled. All major
exporting countries have arrangements to protect exporters and the bankers who provide
their funding support. Avoiding and/or controlling risks in global trade is an everyday
occurrence for importers and exporters. Understanding the instruments available for
avoiding risk is not difficult but is vital. There are essentially four kinds of risks:

Most risks allow for a method of avoidance. Of course, there is no insurance against a
dispute over quality or loss of market as a result of competition, but there are management
instruments for three aspects of risk: not being paid, transport loss or damage, and foreign
exchange exposure.

Avoidance of Commercial Risk

The seller wants to be certain that the buyer will pay on time once the goods have been
shipped. The goal is at least to minimize risk of nonpayment. On the other hand, the buyer
wants to be certain that the seller will deliver on time and that the goods are exactly what
the buyer ordered.

These concerns are most often heard from anyone beginning an import/export business.
Mistrust across international borders is natural; after all, there is a certain amount of mistrust
even in our own culture. One key to risk avoidance is a well-written sales contract. In
Chapter 3 you learned that an early step in the process of international trade is to gain
contract agreement between yourself and your overseas business associate. The terms should
include method of payment.

Getting Paid

Ensuring prompt payment often worries exporters more than any other commercial risk.
The truth is that the likelihood of a bad debt from an international customer is very low. In
the experience of most international businesses, overseas bad debts seldom exceed 0.5

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percent of sales. The reason is that in overseas markets, credit is still something to be
earned as a result of having a record of prompt payment. Use common sense in extending
credit to overseas customers, but don’t use tougher rules than you apply to domestic clients.

The methods of payment, in order of decreasing risk to the seller and increasing risk to
the importer, are open account, consignment, time draft, sight draft, authority to purchase,
letter of credit, and cash in advance. Table 5-1 summarizes the various methods of payment.

Open Account. The open account is a trade arrangement in which goods are shipped to
a foreign buyer without guarantee of payment. Though the riskiest, this method is used by
many firms that have a long-standing business relationship with the same overseas buyer.
Needless to say, the key is to know your buyer and your buyer’s country. You should use an
open account when the buyer has a continuing need for the seller’s product or service. Some
experienced exporters say that they deal only in open accounts. But they always preface that
statement by saying that they have close relationships and have been doing business with
their overseas clients for many years. An open account can be risky unless the buyer is of
unquestioned integrity and has withstood a thorough credit investigation. The advantage of
this method is its ease and convenience, but with open-account sales, you bear the burden of
financing the shipment. Standard practice in many countries is to defer payment until the
merchandise is sold, sometimes even longer. Therefore, among the forms of payment, open-
account sales require the greatest amount of working capital. In addition, you bear the
exchange risk if the sales are quoted in foreign currency. Nevertheless, competitive
pressures may force the use of this method.

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HOT TIP: Relationships between buyer and seller make the difference by reducing mistrust.
Make an effort to meet and get to know your trading partner.

Consignment. In a consignment arrangement, the consignor (seller) retains title to the
goods during shipment and storage of the product in the warehouse or retail store. The
consignee acts as an agent, selling the goods and remitting the net proceeds to the consignor.
Like open-account sales, consignment sales can be risky and lend themselves only to certain
kinds of merchandise. Great care should be taken in working out this contractual
arrangement. Be sure it is covered with adequate risk insurance.

Bank Drafts. Payment for many sales is arranged using one of many time-tested
banking methods. Bank drafts (bills of exchange) are written orders that activate payment
either at sight or at “tenor,” a future time or date. Each is useful under certain circumstances.

A bank draft is a check, drawn by a bank on another bank, used primarily when it is
necessary for the customer to provide funds payable at a bank in some distant location. The
exporter who undertakes this payment method can offer a range of payment options to the
overseas customer.

Time (Date) Draft. The time draft is an acceptance order drawn by the exporter on the
importer (customer), payable a certain number of days after “sight” (presentation) or days
from date to the holder. Think of it as nothing more than an IOU, or promise to pay in the
future.

Documents such as negotiable bills of lading, insurance certificates, and commercial
invoices accompany the draft and are submitted through the exporter’s bank for collection.
When the draft is presented to the importer’s bank, the importer acknowledges that the
documents are acceptable and commits to pay by writing “accepted” on the draft and signing
it. The importer normally has 30 to 180 days, depending on the draft’s term, to make
payments to the bank for transmittal.

Sight Draft. The sight draft is similar to the time draft except that the importer’s bank
holds the documents until the importer releases the funds. Sight drafts are the most common
method employed by exporters throughout the world. They are nothing more than written
orders in standardized bank format requesting money from the overseas buyer. Although
this method costs less than the letter of credit (defined below), it has greater risk because the
importer can refuse to honor the draft.

Bill of lading: A document that provides the terms of the contract between the shipper and the
transportation company to move freight between stated points at a specified charge.
Commercial or customs invoice: A bill for the goods from the seller to the buyer. It is one
method used by governments to determine the value of the goods for customs valuation
purposes. At sight: A term indicating that a negotiable instrument is to be paid upon
presentation or demand.

Authority to Purchase. Authority to purchase is occasionally used in the Far East. It
specifies a bank where the exporter can draw a documentary draft on the importer’s bank.
The problem with this method is that if the importer fails to pay the draft, the bank has
“recourse” to the exporter for settlement. Therefore, before consenting to an authority to

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purchase, the exporter may wish to specify “without recourse” and so state on drafts.

The major risk with the time, sight, and authority to purchase methods is that the buyer
can refuse to pay or to pick up the goods. The method of avoidance is to require cash or a
sight draft against documents. Unfortunately, banks are slow in transferring funds because
they want to use the time float (short-term investment of bank money) to earn interest. Using
a wire transfer can get around the delay.

Letter of Credit (L/C). Ideally an exporter deals only in cash, but in reality few
businesses are initially able or willing to operate under those terms. Because of the risk of
nonpayment due to insolvency, bankruptcy, or other severe deterioration, procedures and
documents have been developed to help ensure that foreign buyers honor their agreements.

The most common form of collection is payment against a letter of credit (L/C). The
L/C is the time-tested method whereby an importer’s bank guarantees payment to the
exporter if all documents are presented in exact conformity with the terms of the L/C. The
procedure is not difficult to understand, and most cities have bank personnel familiar with
the mechanics of L/Cs.

This method is well understood by traders around the world, is simple, and is as good as
your bank. Internationally the term documentary credit is synonymous with letter of credit.
L/Cs involve thousands of transactions and billions of dollars every day in every part of the
world. They are almost always operated in accordance with the Uniform Customs and
Practice for Documentary Credits of the International Chamber of Commerce, a code of
practice that is recognized by banking communities in 156 countries. A Guide to
Documentary Operations, which includes all the standard forms, is available from: ICC
Publishing Corporation, Inc., 156 Fifth Avenue, Suite 302, New York, NY 10010; phone:
(212) 206-1150; fax (212) 633-6025; Web: www.iccbooks.com.

An L/C is a document issued by a bank at the importer’s or buyer’s request in favor of
the seller. It promises to pay a specified amount of money upon receipt by the bank of
certain documents within a specified time or at intervals corresponding with shipments of
goods. It is a universally used method of achieving a commercially acceptable compromise.
Think of a letter of credit as a loan against collateral wherein the funds are placed in an
escrow account. The amount in the account depends on the relationship between the buyer
and the buyer’s bank.

Standby LICs. Sometimes when dealing in an open account, the exporter requires a
standby L C. This means just what the name implies-the LC is executed only if payment is
not made within the specified period, usually 30 to 60 days. Bank handling charges for
standby letters of credit are usually higher than for commercial (import) L/Cs.

Typically, if you don’t already have an account, the bank will require 100 percent
collateral. With an account, the bank will establish a line of credit against that account.

Commercial letter of credit charges are competitive, so you should shop around. Typical
charges are shown in Table 5-2.

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Issuing, Confirming, and Advising Banks. As noted, letters of credit are payable either
at sight or on a time draft basis. Under a sight L/C, the issuing (buyer’s) bank pays, with or
without a draft, when satisfied that the presented documents conform with the forms. An
advising bank (most often the confirming or seller’s bank) informs the seller or beneficiary
that an L/C has been issued. Confirmation means that a local bank guarantees payment by
the issuing bank. Under a time (acceptance) L/C, once the associated draft is presented and
found to be in exact conformity, the draft is stamped “accepted” and can then be negotiated
as a banker’s acceptance by the exporter, at a discount to reflect the cost of money advanced
against the draft.

Once the buyer and the seller agree to use an L/C for payment, and have worked out the
conditions, the buyer or importer applies for the L/C at his or her international bank. Figure
5-1 is an example of a letter of credit application.

Types o f L / Cs. There are two types of letters of credit: revocable and irrevocable.
Revocable credit means that the document can be amended or canceled at any time without
prior warning or notification of the seller. Irrevocable credit means that the terms of the

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document can be amended or canceled only with the agreement of all parties thereto.

Using the application as its guide, the bank issues a document of credit incorporating
the terms agreed to by the parties. Figure 5-2 exemplifies an L/C.

Figure 5-3 shows the three phases of documentary credit in their simplest form. In
Phase I, the buyer’s (issuing) bank notifies the seller through an advising bank or the seller’s
(confirming) bank that a credit has been issued. In Phase II, the seller then ships the goods
and presents the documents to the bank, at which time the seller is paid. In Phase III, the
“settlement” phase, the documents are transferred to the buyer’s bank, whereupon the buyer
pays the bank any remaining moneys in exchange for the documents. Thus, on arrival of the
goods, the buyer or importer has the proper documents for entry.

Special Middleman Uses of the Letter of Credit. There are three special uses of
commercial letters of credit for the import/export middleman: transferable, assignment of
proceeds, and back-to-back L/Cs. Figure 5-4 compares the risks involved with each method.

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Fig. 5-1. Request to open a letter of credit

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Fig. 5-1. Request to open a letter of credit (Continued)

Transferable LIC. Figure 5-5 shows how the transferable L/C works. The buyer opens
the L/C, which states clearly that it is transferable on behalf of the middleman as the original
beneficiary, who in turn transfers all or part of the L/C to the supplier. The transfer must be
made under the same terms and conditions as the original L/C with the following
exceptions: amount, unit price, expiration date, and shipping date. In this instance the buyer
and supplier are usually disclosed to each other.

Assignment of Proceeds. Figure 5-6 illustrates the assignment of proceeds method, and
Figure 5-7 shows a typical letter of assignment. It should be noted that the proceeds of all
letters of credit may be assigned. In this instance the buyer opens the [IC as the beneficiary
and relies on the middleman to comply so that he can be paid. Any discrepancy in
middleman documents will prevent payment under the IJC. The middleman instructs the
advising bank to effect payment to the supplier when the documents are negotiated. In this
way, buyers and sellers are not disclosed to each other.

Back-to-Back L/C. When using the back-to-back method, shown in Figure 5-8, the
middleman must have a line of credit.

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Fig. 5-2. Sample letter of credit

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Fig. 5-3. The three phases of a letter of credit

Fig. 5-4. Comparison of L/C risks

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Fig. 5-5. Transferable letter of credit

The reason is that the middleman is responsible for paying the second (backing) L/C
regardless of receipt of payment under the first (master) L/C. Great care should be
exercised when using this method because discrepancies on the first L/C will result in
nonpayment, and the middleman’s ability to pay could be a substantial credit risk. Back-to-
back L/Cs should be issued on nearly identical terms and must allow for third-party
documents.

Cash in Advance. Cash in advance is the most desirable method of getting paid, but the
foreign buyer usually objects to tying up his or her capital. On the grounds that seeing the
merchandise is the best insurance, most foreign buyers try not to pay until they actually
receive the goods. Furthermore, a buyer may resent the implication that he or she is not
creditworthy.

Avoiding Bad Credit

Pick your customer carefully. Bad debts are more easily avoided than rectified. If there are
payment problems, keep communicating and working with the firm until the matter is
settled. Even the most valued customers have financial problems from time to time. If
nothing else works, request your department of industry or commerce or the International
Chamber of Commerce to begin negotiations on your behalf.

Information that is current and accurate is the backbone of good financing decisions.
Basically there are two types of international credit information: (1) the ability and
willingness of importing firms to make payment, and (2) the ability and willingness of
foreign countries to allow payment in a convertible currency.

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Fig. 5-6. Assignment of proceeds

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Fig. 5-7. Typical letter of assignment

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Fig. 5-8. Back-to-back letter of credit

There are several sources of credit information on companies and their countries.

Information About Domestic Firms

? Commercial banks

? Commercial credit services, such as Dun & Bradstreet

? Trade associations

Information About Foreign Firms

? National Association of Credit Management (NACM)

? Foreign credit specialists in the credit departments of large exporting companies

? Commercial banks, which check buyer credit through their foreign branches and
correspondents

? Commercial credit reporting services, such as Dun & Bradstreet

? Consultations with EXIMBank and the Foreign Credit Insurance Association (FCIA)

? The U.S. Commerce Department’s World Trade Directory Reports

Information About Foreign Countries

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? World Bank

? Chase World Information Corporation

? Institutional Investor magazine

? National Association of Credit Management (NACM)

Avoiding Shipping Risks

Marine cargo insurance is an essential business tool for import/export. Generally, coverage
is sold on a warehouse-to-warehouse basis (i.e., from the sender’s factory to the receiver’s
platform). Coverage usually ceases a specific number of days after the shipment is
unloaded. Policies are purchased on a per shipment or “blanket” basis. Freight forwarders
usually have a blanket policy to cover clients who do not have their own policy. Most
insurance companies base cargo insurance on the value of all charges of the shipment
(freight handling, etc.) plus 10 percent to cover unseen contingencies. Rates vary according
to product, client’s track record, destination, and shipping method.

Ocean cargo insurance costs about $0.50 to $1.50 per $100 of invoice value. Air cargo
is usually about 25 to 30 percent less.

Avoiding Political Risk

No two national export credit systems are identical. However, there are similarities, the
greatest of which is the universal involvement of government through the export credit
agency concerned and of the commercial banking sector through the workings of the
system.

Most countries have export-import banks. In the United States, EXIMBank provides
credit support in the form of loans, guarantees, and insurance. All EXIM branches cooperate
with commercial banks in providing a number of arrangements to help exporters offer credit
guarantees to commercial banks that finance export sales. The Overseas Private Investment
Corporation (OPIC) and the Foreign Credit Insurance Association (FCIA) also provide
insurance to exporters, enabling them to extend credit terms to their overseas buyers. Private
insurers cover the normal commercial credit risks; EXIMBank assumes all liability for
political risk.

For more information on FCIA, contact: FCIA, Marketing Department-11th Floor, 40
Rector Street, New York, NY 10006; phone: (212) 306-5000; fax: (212) 306-5218.

The programs available through OPIC and FCIA are well advertised and easily
available. Commercial banks are essentially intermediaries to EXIMBank for export
guarantees on loans (beginning at loans up to 1 year and ending at loans of 10 to 15 years).
FCIA offers insurance in two basic maturities: (1) a short-term policy of up to 180 days, and
(2) a medium-term policy from 181 days up to 5 years. You may also obtain a combination
policy of those maturities. In addition, FCIA has a master policy offering blanket protection
(one policy designed to provide coverage for all the exporter’s sales to overseas buyers).

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Avoiding Foreign Exchange Risk

When the dollar is strong-as strong as it was in the early 1980s-traders prefer to deal in the
dollar. When the opposite is true, traders begin to deal in other currencies. Of course, the
dollar is as good as gold because it is a politically stable currency that is traded
internationally. Because of its stability, it has become the vehicle currency for most
international transactions.

So long as exporters deal only in their own currency, there is no foreign exchange risk.
However, the strength and popularity of currencies are cyclical, and the dollar is not always
the leader. Often, an exporter is faced with the prospect of pricing products or services in
currencies other than dollars. Importers must buy foreign currency to pay for products and
services from risk-avoiding foreign suppliers that demand payment in their own currency. In
the current era of floating exchange rates, there are risks of exposure whenever cash flows
are denominated in foreign currencies.

Exposure: The effect on a firm or an individual of a change in exchange rates.

Forward or future exchange rate: The rate (agreed-on

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