Real Time Currency Trading Instructor
Forex: Credit and the hedging functions
Credit functions follow the truism that debits and credits should be balanced. And so is the reciprocity of international payments. In cases where importers cannot pay cash in advance or on delivery, there are several methods to resolve credit. One method, the importer can deliver payment for a stated period of time. Another method is the use of time drafts, where "the exporter and importer agree to extend their credit to each other, which alleviates the importer of payment before credit expiration. The drafts, as the case may be, is where an importer is allowed to get credit, while the exporter gets to hold the draft signed by him and the importer till the maturity date or the discountenance of ever getting borrowed against them.
In a hedging function, the foreign trader faces the risk that the buyer would fail to make payment. When that happens, the usual trouble is the exchange risk that arose on the time that credit elapsed or the fluctuation that occurred within the time of credit. For example, an importer bought goods invoiced at £1000 from the Englishman, which at the time the dollar-sterling rate closed at $4.90. If the importer fails to make delivery and has been given 30 days, he would have to pay the Englishman an increase if and when dollar-sterling rate improves to $4.92, which means the importer will have to pay $20 more to the exporter. Conversely, the exporter might pay less if and when the dollar-sterling rate weakens to, say, $4.88, which makes the exporter receive $20 less of the payment.
Because of this exchange risk, some currencies resort to forward marketing, where the strengthening and weakening of the currency value is forecasted and thoroughly studied by looking at trends and weakness of economies. This involves a lot of research. Foreign traders don't have time to look at all available information because they come from hundreds of sources, but they do rely on what they found out and take a chance from there. As in all foreign trade, they are trying to determine the complex behavior of currency rates, which involves transactions and currency fluctuations from all over the world.
Basically, currency fluctuations give economies two opportunities of either allowing their monetary value to strengthen or to depress. Before this was not the case. Many countries including the United States before the First World War wanted a fix rate in their monetary system and so made gold as the ultimate standard of value. Countries resorted to this to make their economy stable and the rates of exchange became fixed.
