In today's global economy, companies looking to grow theirbusiness should consider sourcing and selling in foreign markets.Whether the organization is a subsidiary of a foreign company or aU.S.-grown business looking to expand overseas, the treasury teamneeds to understand all their alternatives for structuring foreignpayments and receipts.

Handling overseas financial transactions is no easy feat.Managing currency exposures, pricing, foreign bank services, andoverseas counterparty risks may leave any domestic treasury stafffeeling overwhelmed. Here are some key considerations for managingcorporate finances in a foreign country.

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Currency in the Supply Chain

First, it's important to address the question of which currencyto use in transacting with foreign counterparties. Consider thedecisions a U.S.-based organization makes in building a supplychain abroad. Many such companies believe they can eliminateforeign exchange (FX) risk by conducting international transactionsin U.S. dollars. Unfortunately, the truth is that FX volatility risk is always present. Bytransacting in its own functional currency, a U.S.-based businessends up passing on the FX risk to its suppliers—many of whom willcharge a premium for assuming the risk, and/or may fail to managethe risk appropriately.

In addition to the financialrisks, insisting on transacting in U.S. dollars may pose acommercial risk. Take international franchisors as an example. In acompetitive market for quality franchisees abroad, invoicing inU.S. dollars will burden operators who do business in their localcurrency by forcing them to pay for an FX conversion before theycan pay royalties. The result is an increase in the cost offranchising, which could serve as a disincentive to choose thatparticular franchise.

We suggest that companies consider transacting in foreigncurrencies to avoid these and other problems. Here are somebenefits associated with purchasing in local currency instead ofU.S. dollars (USD):

• Reduce costs. When a supplier invoices in USDvs. local currency, the supplier assumes all of the exchange raterisk and may increase its USD-denominated prices to protect itselffrom currency market movement between the invoice date and paymentdate. Depending on the terms and the currency, this could be apremium of 10 to 15 percent or more. Any drastic movements in thecurrency also invite additional price negotiations.
• Improve visibility into FX rates. Obtaincompetitive exchange rates from the bank and know the exact amountof foreign currency paid to suppliers. The premium you pay fortransacting in USD includes not only an FX risk premium, but also asales premium that is applied by the supplier's bank. Paying inlocal currency gives the buyer control over the FX premium and abetter understanding of the FX costs.
• Negotiate more favorable payment terms.Payments in a foreign currency typically post faster to beneficiaryaccounts. Also, buyers that reduce suppliers' costs for FXconversion and risk management typically can ask for better paymentterms in return. For the supplier, transacting in the localcurrency is a significant benefit, which should give the buyer moreleverage in negotiations.

What if a company is sourcing from a related entity, such as aparent company? Even in that case, it is important to considerwhere the exchange rate risk lies and which party to thetransaction is best suited to manage it. For example, consider theU.S. subsidiary of a German company that purchases all itsinventory from the parent company. The U.S. group represents 5percent of the overall company, and the German parent sets pricingin U.S. dollars once per year. Finance managers in the U.S.business may want to ask how the parent company is managing eachyear's worth of exchange rate risk. Does the parent have a strategyin place to protect against market movement? Is there any situationin which pricing could change—such as if the market movessignificantly? As only 5 percent of the overall business, thisexchange rate risk may not be a priority for the German company,but it creates a significant risk for the U.S. entity and maycreate an incentive to over-purchase anytime prices are due to bereset higher.

We suggest discussing these factors with all the company'sforeign suppliers—whether they're related entities or externalorganizations—and revisiting it regularly, to avoid a shock to yourbusiness from an unforeseen market change.

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Customer Payments

Companies that sell internationally may also prefer to havecustomers pay in U.S. dollars. However, customers in ourincreasingly global economy expect to see prices denominated intheir local currency. Accepting payments in a foreign currency willopen up new opportunities with customers that want—or potentiallyneed—to make payments in their local currency. Additionally,selling internationally in USD makes products and services moreexpensive in a stronger dollar environment, so the company runs therisk of losing business to local competitors in the foreign marketswhere it does business.

For global commerce, everyone wants a local experience. The morean international company can remove the friction of cross-bordertransactions, the better positioned it is to compete in foreignmarkets.

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Closing the FX Trade

Once a U.S.-based company makes the decision to either pay oraccept payments in a foreign currency (or both), it needs todetermine the appropriate type of foreign exchange transaction fortranslating its cash flows from the foreign currency back to U.S.dollars. FX transactions are generally either spot or forwardcontracts.

• A spot contract is a legally binding agreement to sell onecurrency and buy another on the nearest standard settlement (value)date. The exchange rate is based on the prevailing market rate twodays before settlement. In other words, this is a 'buy now, paynow' deal at the current market exchange rate. Some benefits of spot contracts include easyoperation, 24-hour trade access, and their lack of depositrequirements.
• A forward contract is a legally binding agreement to buy onecurrency and sell another at some point in the future. The forwardcontract specifies the amount of the transaction, the settlementdate, and the rate that will be used, which is based on theprevailing market rate. In other words, forward contracts are “buynow, pay later” products, which enable the parties to lock in anexchange rate for a set date in the future. Forwards involve oneparty that agrees to “buy” at a later date (taking the longposition in one currency) and a second party that agrees to “sell”at a later date (taking the short position in that currency). Theadvantages of forward contracts include the ability to choose arate that is advantageous, as well as the ability to manage andforecast cash flows without worrying about future FXvolatility.

As the FX market evolves, new solutions continue to beintroduced. One recent innovation is the introduction of aguaranteed FX rate program. If a company would like control overthe exchange rate for future transactions but doesn't know theexact dates the FX payments will be sent or received, a guaranteedFX rate enables it to lock in a monthly rate for all its FXtransactions without having to specify dates and amounts. Newsolutions like the guaranteed rate will continue to make globalbusiness easier to execute.

An alternative approach for mitigating exchange rate risk is toopen a foreign currency account. This can be an ideal solution whenan organization is both selling products and purchasing materialsin the same currency. By using a foreign currency account, acompany protects itself from currency volatility to the degree thatits volume of receivables matches its anticipated payableneeds.

However, opening a foreign currency account does introduce someadditional risks. The potential for sovereign risk varies bycountry. There are also operational risks related to managing theaccounts and the risk of holding idle foreign currency balances.Treasury teams opening a foreign currency account must determinewhether the volume and transaction activity outweigh the costs andrisks.

A finance professional or banking partner can be a crucialsource of information for companies starting to expand globally.With the right guidance and planning, treasurers can make the bestdecisions for their organization on managing their out-of-countryassets.

Doug Houser is thehead of Cross Currency Solutions Sales for Bank of America MerrillLynch. He is responsible for the strategy and execution for thedistribution of BofA Merrill's FX payments product suite in theAmericas. His team is responsible for designing and deliveringbest-in-class foreign exchange and transaction solutions to Bank ofAmerica Merrill Lynch's global client base.

Lesley White is thehead of Global Commercial Banking International for Bank of AmericaMerrill Lynch, based in London. Sheprovides a single point of management across the full spectrumof solutions the bank provides to the subsidiaries of its U.S.headquartered Global Commercial Banking clients. In addition, shehelps coordinate the teams in treasury solutions, credit products,and client coverage to best serve the needs of the bank's middlemarket clients globally.

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