Foreign Exchange: Use of the Forward Market

The American exporter rather generally keeps his export drafts in dollars and throws the exchange risk onto the foreign importer. In contrast, the American importer buys to a very considerable extent in foreign currency, thus bearing the exchange risk. When the American exporter does draw in foreign currencies he does so because:

(1) he has been accustomed to it through many years of experience;

(2) the drawee urges it as more convenient;

(3) he follows the lead of his competitors;

(4) a particular foreign exchange--e.g., sterling-may be more plentiful in the importer's market than is dollar exchange. Whatever the reason, it is apparent that on the whole the exporter prefers his own currency as the basis for foreign trading.

The American importer is clearly more willing to deal in foreign exchange, may even prefer that the terms of sale be expressed in foreign currency rather than in dollars.

What do the relatively few American exporters and the relatively many American importers who assume an exchange risk do about it? Do they let the risk run, taking a chance on the possible loss, or do they by one means or another "cover" the risk?

Use of the Forward Market

Unfortunately, to that question it is not possible to give a precise answer backed by convincing statistical evidence. So far as foreign trade in manufactured goods is concerned, this may be said: of the American exporters interviewed who to some extent sell in foreign currencies, about one-third were covering the exchange risk by a forward sale of the resulting foreign exchange. Of the American importers of manufactured goods who were buying in foreign currency, about one-third reported that they habitually and one-fifth that they occasionally covered the exchange risk by a forward purchase of the foreign exchange which will subsequently be needed. Concerning the extent to which American foreign traders in "staple" foods and raw materials cover exchange risks by recourse to the forward exchange market we cannot be so precise. It is probable that they do so more generally than do the traders in manufacctures, and this for three reasons:

(1) They are likely to be import and export houses of long standing, fully familiar with the routine of forward transactions.

(2) They are dealing in commodities which are, in domestic trade, bought and sold in organized exchanges in which commodity "futures" are part of the recognized machinery. To a firm which is accustomed to one sort of futures trading, another presents no problems. For example, it is not surprising that all the flour mills questioned reported that they invariably disposed of their foreign exchange by sales under forward contracts if we recall that flour millers habitually hedge against changes in the price of wheat by means of wheat "futures."

(3) They operate on a close margin of profit and cannot afford to take any exchange risk.

Why Many Foreign Traders Do Not Use the Forward Market

We may venture the guess, then, that the exporters and importers who make no use of the forward exchange market in order to cover their foreign exchange positions have these various reasons for not utilizing forward contracts:

1. They prefer to speculate in exchange.

2. They believe experience shows that exchange risk in the long run is negligible.

3. They are exporting in terms of currencies for which there is no forward market or for which the forward rates are prohibitive.

4. They find other means than the forward market by which exchange risks can be covered.