Excluding foreign exchange risks, discuss, with examples, how the risks of foreign trade might be managed.

Advanced Financial Management Block Revision Mock Exams

The management of risk associated with foreign trade will depend upon the nature of the risk. The risks include:

(a) Commercial risk is that the client will only pay after the due date. It may be managed by:

(i) Credit screening prior to the contract being signed. This might include formal credit evaluation through a credit agency, use of information from trade associations, government databases, bank references or trade references.

(ii) The terms of sale. Some terms of sale involve much less risk than others. Most secure (but not common) is cash in advance. Others, in order of increasing risk include cash on delivery, documentary letters of credit, bills of exchange and open account.

(iii) The method of payment. The quicker and more secure the method of payment, the lower the risk. Extremes range from secure electronic funds transfer to sending a cheque in the post.

(iv) Insurance against non-payment or late payment. In many countries this is offered through government agencies. In the UK short-term insurance providers include NCM and Trade Indemnity.

(b) Physical risk, the risk of damage or theft in transit is best managed through insurance cover.

(c) Political risk is risk of non-payment or late payment as a result of the actions of a foreign government, e.g. through the introduction of exchange controls, tariffs or quotas. Political risk protection is often offered by the same insurers as commercial risk. Political risk might also be avoided by using different forms of international activity, e.g. tariffs and quotas might be avoided by direct investment in the country concerned, exchange controls might be avoided by engaging in counter trade rather than cash trade.

(d) Cultural risk is risk associated with different cultures, ways of doing business, attitude to religion, colours, gender, food and drink etc. In order to reduce such risk thorough research of the local market, culture, and business practices should be undertaken prior to trading.

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