The car sale used in the illustration is likely to be billed in either sterling (the currency of the seller) or U. S. dollars ( the currency of the buyer) . Of course, any currency can be chosen for the transaction, as long as both parties agree to it.
If the sale is invoiced in sterling, then U. S. Corporation will probably have to convert U. S. dollars, its home currency, into sterling. This conversion is done with its bank, Chase Manhattan. As the example shows, U. S. Corporations' s dollar payment in the exchange transaction represents a reduction in dollars deposits at Chase. In order for Chase to deliver sterling to U. S. Corporation, it has to draw on its sterling balances. These sterling balances are, in fact, deposits that Chase maintains with a British bank - Chase ' s correspondent bank in England - say, Barclays. At Barclays (which we have assumed to be ABC's bank also), there will be a change in the ownership of 1 million sterling deposits from Chase to ABC Corporation, assuming an exchange rate between U.S. dollars and British pound of one to one.
If the trade transaction is denominated in U.S. dollars and if ABC Corporation is still interested in converting the dollar proceeds into sterling, then the exchange transaction will take place as Barclays, ABC's bank in England. ABC will present to Barclays a check (for U. S. S 1 million) drawn on Chase Manhattan. At the assumed exchange rate, ABC receives in exchange 1 million sterling deposits with Barclays. At Barclays, there is an increase in sterling deposits ( ABC' s account ) and an increase in U. S. dollar balances, which are maintained with Chase. At Chase, there is only a change in the ownership of dollar deposits from U. S. Corporation, -to ABC's Corporation, and to Barclays.
In this example, one of the trading parties must enter a foreign exchange transaction regardless of the currency in which the export sale is billed. If the sale is denominated in sterling, the U. S. buyer has to make the foreign exchange transaction. If the sale is billed in dollars, it is the British exporter who must complete the foreign exchange transaction. Of course, this does not to be the case in every transaction. In our example the U.S. importer may have already had balances in sterling, or the British exporter may have been willing to hpld d:}llar balances in payment for the export sale. However, given that the revenues of the buyer(U. S. Corporation) are likely to be denominated in U. S. dollars, and that the costs of seller (ABC Corporation) are likely to be denominated in sterling, the exchange transaction will be necessary more often than not.
After the described transaction, the exporter and the importer satisfy the neeed international transfer of funds. However, the commercial banks may have a .problem.. If we assume that both Chase and Barclays initally had exactly the amount of foreign exchange they wish to hold, then after the settlement of the import payment one of the banks has an amount of foreign exchange different from what it wishes to have. Depending on the currency of the sale, Chase or Barclays will have to sell dollars and buying sterling to revert their exposure to exchange risk to the initial position.
