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Foreign Currency Advance



 

Foreign Currency advance is n hedging technique, which enables Exporters to avoid the risks resulting from a deferred payment denominated in a foreign currency. This service is usually provided by a commercial Bank, which will borrow the needed foreign currency for his client.

Let’s take the example of a French exporter and a US Importer who concluded a 10 000 000 USD deal with a 90-day payment term. In order to neutralize his currency risk exposure, the exporter will apply for a foreign currency advance. The commercial bank will then borrow this amount and lend it to the exporter, which will have to repay in USD at a given date (this should in line with payment maturity agreed in the export sales contract) + interest denominated in USD.

Once the funds are available in the French Exporter’s bank account, he will immediately change the USD against EUR and by then avoid his exposure to the foreign currency.

In this case the exporter will honour his obligations by using the payment received by the US Importer 90 days later.

As we can see this method enables to avoid most of the currency risks linked to his sales contract although the exporter remains exposed to the currency risks resulting from the interest charged by his bank that must be repaid in the foreign currency (Which is marginal compared to the whole operation).

Note that this method could be used as both, a financing tool as well as a currency-hedging tool.

Please click on the links below for more hedging techniques