Forex: Payments Over Varying Periods
To see why the procedure of the examples is not always the way to handle the foreign currency problems or why it may not be practical, it would not hurt to examine the assumptions, some expressed, some tacit, on which the transactions were based.
To start with, it was assumed that the transaction was entered into at a particular moment in time. That is fine for an order received on a particular date to be filled out of inventory and delivery within a fixed period. But what about the situation in which it is necessary to quote prices in another currency subject to the customer's acceptance?
Now there is no fixed starting date as far as the quotation is concerned, and a forward contract matching up the exact dates cannot be entered into.
As an example, a French customer requests a quotation in French francs for equipment in late July of 1969 from a U.S. exporter. The exporter quotes a price of FF 1,000,000, equivalent to approximately $200,000 at that time, without trying the quote to the existing U.S. dollar-French franc relationship. The franc is devalued on August 8, 1970.
The French importer accepts the quotation, for delivery and payment in 90 days, but his acceptance is not received until August 10. The exporter now finds that he will receive approximately $180,000. That amount could be protected against changes for the 90-day period, but the loss has already occurred.
The other side of this does not follow. If the French importer receives a quotation in dollars, his acceptance gives rise to his exchange exposure and at that time he enters into a forward exchange contract. After the devaluation of the franc, he has to reconsider the desirability of a specific purchase in terms of the additional cost in francs.
To examine the payment date assumption, a U.S. exporter again makes a sale for French francs calling for payment of FF 1,000,000 on July 31, 1969. The sale can be made on open account or against a note due on July 31, or in a number of other ways. Payment is not received by the exporter on July 31, or in a number of other ways.
Payment is not received by the exporter on July 31, either because the customer delays or because of paperwork problems, and is not made until August 1. Assume the exporter has covered the transaction by selling the French francs forward for delivery July 31 at $0.199 per franc. The spot rate for value July 31 is $0.201 per franc.