Forex: Timinmg of Payments in Forex

The possibilities that exist for purchasing forward coverage for specific export-import transactions were pointed out and explained; it is easier for the payor to purchase coverage, since he can determine the timing of payment precisely.

In addition to export-import transactions, we have discussed other types of payments in which the timing of payment may be even less precise. It is, in fact, not necessary that forward coverage be linked to specific transactions.

A company that is involved in foreign business and has a good credit rating may generally arrange, through its normal banking courses, to buy or sell foreign currencies for future delivery in amounts related to its business needs. Banks may, however, frown on transactions entered into purely for speculative purposes not related to specific foreign operations.

The timing and extent of forward coverage that is obtained can be related to the probable exposures a business will have. For instance, a company wishes to make quotations in a foreign currency as in the example of the French importer. French francs can then be sold forward for the approximate period the quotation is expected to be outstanding; if the quotation is accepted, a new contract can be entered into for the approximate date by which payment might be expected.

Alternatively, French francs might be sold forward in the beginning for the entire probable period of the transaction. If the quotation is not accepted, it is possible to purchase French francs forward for the same date as previously sold, which will result in a cost for the period of the quotation only.

Although the forward market in major currencies is quite flexible, it is usually easier for nonspecific transactions to deal in round 100,000 amounts of the currencies concerned. In a good many currencies, that is the equivalent of $25,000 to $30,000 more or less, and the quotations given by the banks are simpler.

Similar considerations affect payments such as royalties. Instead of expediting payments to be made that are denominated in a strong currency or payments to be received that are denominated in a weak currency, forward coverage to eliminate the exposure can be obtained. In the first case, the strong currency would be purchased forward and used when payments would normally be due.

In the second, the weak currency would be sold forward and the actual currency received would be delivered when due. The amount of coverage should be related to the amounts involved.

Determining the amount may not be simple, particularly when monthly or other regular payments are involved. For instance, should coverage be obtained on an annual basis equivalent to one month's royalty payments, one year's or what amount? The decision should be based on the cost, the probable risks, and the loss a particular business is prepared to accept.