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Unformatted text preview: reign currency. Not only must a U.S.
company pay the costs of doing business in the foreign exchange market, but it
also is exposed to exchange rate risk. A U.S.-based company that exports goods
and has accounts receivable denominated in a foreign currency faces the risk that
the U.S. dollar will appreciate in value relative to the foreign currency. The risk to
a U.S. importer with foreign-currency-denominated accounts payable is that the
dollar will depreciate. Although exchange rate risk can often be hedged by using
currency forward, futures, or options markets, doing so is costly and is not possible for all foreign currencies.
Typical international transactions are large in size and have long maturity
dates. Therefore, companies that are involved in international trade generally
have to finance larger dollar amounts for longer time periods than companies
that operate domestically. Furthermore, because foreign companies are rarely 9. Commercial banks are legally prohibited from lending amounts in excess of 15% (plus an additional 10% for
loans secured by readily marketable collateral) of the bank’s unimpaired capital and surplus to any one borrower.
This restriction is intended to protect depositors by forcing the commercial bank to spread its risk across a number
of borrowers. In addition, smaller commercial banks do not have many opportunities to lend to large, high-quality
business borrowers. CHAPTER 15 Current Liabilities Management 649 well known in the United States, some financial institutions are reluctant to lend
to U.S. exporters or importers, particularly smaller firms. Financing International Trade
letter of credit
A letter written by a company’s
bank to the company’s foreign
supplier, stating that the bank
guarantees payment of an
invoiced amount if all the
underlying agreements are met. Several specialized techniques have evolved for financing international trade. Perhaps the most important financing vehicle is the letter of credit, a letter written b...
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