11 - Financing Foreign Trade

Question 1

Foreign trade: four principal means of payment terms

Answer 1

1. Cash in advance (rare; good for exporter)
2. Letter of credit
3. Drafts
4. Open Account (good for importer; getting more popular because of more export competition, information on credit worthiness)

Question 2

Cash in Advance

Answer 2

• Minimal risk to exporter

- Used where there is a) Political unrest, b) new and unfamiliar customer

Question 3

Letter of Credit (L/C)

Answer 3

A letter addressed to the seller
-written and signed by buyer's bank
-promising to honor seller's drafts
-bank substitutes its own commitment
-seller must conform to terms
(see L/C diagram in slides)

Question 4

Advantages of L/C to Exporter

Answer 4

• Eliminates credit risk
• Reduces the risks of exchange control (gov restrictions on exchange of foreign currency)
• Pre-shipment (cancellation of the order) risk protection

Question 5

Advantages of L/C to Importer

Answer 5

• Shipment reassured
• Documents inspected
• May allow better sales terms
• Relatively low-cost financing
• If discrepancies, easy cash recovery

Question 6

Draft

Answer 6

• An unconditional order in writing - signed by the exporter (seller) and addressed to the importer (buyer) ordering the importer to pay:
  
  • at once (sight draft), or
  • in future (time draft; matures at future date)

Question 7

Three functions of drafts

Answer 7

1. Clear evidence of financial obligation
2. Reduced financing costs
3. Can be a financial product for investors (may be converted into a banker’s acceptance)

Question 8

Open Account

Answer 8

• Creates a credit sale
• To importer’s advantage
• More popular lately because:
  
  • major surge in global trade
  • credit information improved
  • more global familiarity with exporting

Question 9

Advantages / Disadvantages of Open Accounts

Answer 9

ADV: greater flexibility in making a trade; lower transaction costs
DISADV: highly vulnerable to government currency controls

Question 10

Documents used in international trade: Bill of Lading

Answer 10

1. Acts as a contract to carry the goods
2. Acts as a shipper’s receipt
3. Establishes ownership over goods if negotiable type

Question 11

Documents used in international trade: Commercial Invoice

Answer 11

• Lists full details of goods shipped
• Names of importer/exporter given
• Identifies payment terms
• List charges for transport and insurance

Question 12

Documents used in international trade: Insurance Certificate

Answer 12

• Marine insurance policy covers sea as well as air transport
• Insurance certificate issued to show proof of insurance

Question 13

Short-term financing techniques; Bankers’ Acceptance

Answer 13

• A time draft drawn on a bank
• By accepting the draft, the bank makes unconditional promise to pay the holder a stated amount on a specified day (see diagram in slides)