Financing foreign trade

Question 1

What are the five principal means of payment?

Answer 1

1. Cash in advance
2. Letter of credit
3. Draft
4. Consignment
5. Open account (the seller has little evidence of the importer’s obligation to pay a certain amount at a certain date.)

Question 2

What are the different types of letter of credit?

Answer 2

1. Documentary/non-documentary (clean)
   Documentary - the seller must submit, together with the draft, any necessary invoices and the like
2. Revocable/irrevocable
   Irrevocable - cannot be revoked without the specific permission of all parties concerned, including the exporter
3. Confirmed/unconfirmed
   A confirmed UC is an UC issued by one bank and confirmed by another, obligating both banks to honour any drafts drawn in compliance.

Question 3

Which parties are involved in letter of credit? What are their roles?

Answer 3

1. Drawer (who initiate the draft - signs a draft and send it)
2. Drawee (the receiver of the letter - who has to pay - The party to whom the draft is addressed)
3. Payee (payment is made to the third party, the payee; usually the same as the drawer)

Question 4

What are some other ways to get security of payment?

Answer 4

1. Factoring
2. Forfaiting
3. Insurance

Question 5

What is the relationship between EximBank and Foreign credit insurance association?

Answer 5

In the United States, the export-credit insurance program is administered by the Foreign Credit Insurance Association (FCIA)-a cooperative effort of Eximbank and a group of approximately 50 of the leading marine, casualty, and property insurance companies.

Question 6

What are the two types of factoring?

Answer 6

Factoring - factors have the title to receivables;

1. Factoring with recourse
2. Factoring without recourse (responsible for credit checking and collecting the receivables)

Question 7

What are the three forms of countertrade?

Answer 7

1. Barter (Barter is a direct exchange of goods between two parties without the use of money. For example, Iran might swap oil for guns.)
2. Counter purchase (If you buy mine, I will buy yours. Sale of goods and services to one company in other country by a company that promises to make a future purchase of a specific product from the same company in that country.)
3. Buyback (repayment of the original purchase price through the sale of a related product. For example, Western European countries delivered various pipeline materials to the former Soviet Union for construction of a gas pipeline from Siberian gas fields and in return agreed to purchase 28 billion cubic meters gas per year.)

Question 8

What is a negotiable instrument?

Answer 8

A document that promises payment to a specified person or the assignee.

Question 9

What are the advantages of L/C to importers?

Answer 9

a) any documents required are carefully inspected by clerks with years of experience
b) an L/C is about as good as cash in advance, so the importer usually can command more advantageous credit terms and/or prices.
c) the importer using an L/C can usually command better credit terms and/or prices
d) L/C financing may be cheaper than the alternatives
e) If prepayment is required, the importer is better off depositing its money with a bank than with the seller because it is then easier to recover the deposit if the seller is unable or unwilling to make a proper shipment.

Question 10

What is a bank draft?

Answer 10

Think of it as a cheque.

There are three functions:

1. It provides written evidence, in clear and simple terms, of a financial obligation.
2. It enables both parties to potentially reduce their costs of financing.
3. It provides a negotiable and unconditional instrument. (That is, payment must be made to any holder in due course despite any disputes over the underlying commercial transaction.)

A type of check where the payment is guaranteed to be available by issuing bank. Typically, banks will review the bank draft requester’s account to see if sufficient funds are available for the check to clear. Once it has been confirmed that sufficient funds are available, the bank effectively sets aside the funds from the person’s account to be given out when the bank draft is used.

Question 11

What documents accompany a documentary letter of credits?

Answer 11

a) bill of lading in negotiable form
b) commercial invoice
c) insurance certificate

Question 12

What are the important attributes of bankers’ acceptance?

Answer 12

a) makes an unconditional promise to pay the holder of the draft a stated amount on a specified day
b) effectively substitutes its own credit for that of a borrower
c) creates a negotiable instrument that may be freely traded

Unless a bank has accepted a draft, the exporter ultimately must look to the importer for payment. Thus, use of a sight or accepted time draft is warranted only when the exporter has faith in the importer’s financial strength and integrity.

By “accepting” the draft, the bank makes an unconditional promise to pay the holder of the draft a stated amount on a specified day.

Question 13

What are the advantages of L/C to exporters?

Answer 13

a) an L/C eliminates credit risk if the bank that opens it is of undoubted standing
b) an L/C reduces the danger that payment will be delayed or withheld due to exchange controls or other political acts (Countries generally permit local banks to honour their letters of credit. Failure to honour them could severely dam- age the country’s credit standing and credibility.)
c) an L/C guards against pre-shipment risks
d) reduces uncertainty. The exporter knows all the requirements for payment because they are clearly stipulated on the Uc.
e) Last, and certainly not the least, the L/C facilitates financing because it ensures the exporter a ready buyer for its product. It also becomes especially easy to create a banker’s acceptance- a draft accepted by a bank.

Question 14

What is the difference between factoring and forfaiting?

Answer 14

Unlike factors, forfaiters typically work with the exporter who sells capital goods, commodities, or large projects and needs to offer periods of credit from 180 days to up to seven years.

medium-term export receivables denominated in fully convertible currencies (U.S. dollar, Swiss franc, euro). This technique is generally used in the case of capital-goods exports with a maturity and repayment in semiannual instalment. The discount is set at a fixed rate: about 1.25% above the local cost of funds.

Use factoring: 1) not familiar with customers’s creditability 2) small orders/short-terms 3) not capital goods

Question 15

What are the two types of draft?

Answer 15

1. Time draft (are payable at some specified future date and as such become a useful financing device) - documents are delivered on acceptance, it is a D/A draft
2. Sight draft (must be paid on presentation or else dishonoured) - D/P (documents against payment)

Question 16

A bankers’ acceptance’ marketability is greatly enhanced because…

Answer 16

a) the authenticity of an accepted draft is separated from the underlying commercial transaction
b) the accepted draft may not be dishonored for reason of a dispute between the exporter and importer

Question 17

What are the true economic rationale for countertrade?

Answer 17

a) many Third World countries use countertrade to conserve what little foreign exchange they have
c) countertrade enables members of cartels such as OPEC to undercut an agreed upon price without formally doing so
d) the trade may circumvent tariffs

Used when:

1) with developing countries with “soft-currency”
2) when tariffs or quotas prevent trade

Question 18

Why would Letter of Credit benefit both the importer and exporter?

Answer 18

1. the exporter selling on credit may wish to have importer’s promise of payment backed by a foreign or domestic bank
2. the importer may not wish to pay the exporter until it is reasonably certain that the merchandise has been shipped in good condition.

Question 19

What are the steps using letter of credit?

Answer 19

Stage 1: creation of letter of credit

1. Purchase order
2. US Importer obtains a L/C paid at maturity from US bank
3. US bank delivers the L/C to the Japanese bank
4. Japanese bank gives the Japanese exporter the L/C notification

Stage 2: Goods delivery and payment

5. Good shipment

DRAFT ISSUANCE

6. Japanese bank helps the exporter to issue draft, gather shipping documents
7. Japanese bank delivers the documents, draft and L/C to the US bank

BANKER’s ACCEPTANCE

8. US bank accepts the draft and delivers the money
9. Japanese bank receives the money and delivers to the exporter
10. US bank forwards the shipping documents to US importer
11. US importer pays the bank at maturity

Question 20

What is a transferrable L/C?

Answer 20

A transferable L/C is one under which the beneficiary has the right to instruct the paying bank to make the credit available to one or more secondary beneficiaries.

Question 21

What documents are required for a draft?

Answer 21

1. bill of lading
2. insurance certificate
3. commercial invoice
4. If required, consular invoice

Question 22

What is the point of issuing a time draft for acceptance?

Answer 22

1. the exporter is extending credit to the importer for the usance of the draft.
2. the exporter is relinquishing control of the goods in return for a signature on the acceptance to assure it of payment.

Question 23

What are the three functions of bill of lading?

Answer 23

1. It is a contract between the carrier and shipper (exporter) in which the carrier agrees to carry the goods from port of shipment to port of destination.
2. It is the shipper’s receipt for the goods.
3. The negotiable B/L, its most common form, is a document that establishes control over the goods.

Question 24

What can a bank do when it accepts a draft and paid the exporter? (it is in deficit now)

Answer 24

The accepting bank may either

1) buy (discount) the B/A and hold it in its own portfolio
2) sell (rediscount) the B/A in the money market (the importer will pay the bank at maturity, but bank needs cash now - sell the acceptance now and get paid, pay the investor after receiving cash from importer)

Question 25

Exporter has two choices when getting the bankers’ acceptance (time draft)

Answer 25

1) Hold it (get money in 90 days = money in 90 days + acceptance fee)
2) Sell it in the market (get the money now at a discount = money today + discount + acceptance fee)

Remember the fee is always in per annum term - be careful!

Question 26

What if the bank does not accept the draft?

Answer 26

The exporter can get cash by discounting

The exporter places the draft with a bank or other financial institution and, in turn, receives the face value of the draft less interest and commissions.

Question 27

What is the difference between discounting and factoring?

Answer 27

Factoring includes the service of payment collection, which is why it is more expensive than discounting.
The customers dont know discounting, but they are informed of factoring.

Question 28

What are the principal functions of Eximbank?

Answer 28

1. Direct loans to exporters
2. Intermediate loans to exporters
3. Loan guarantees (repayment protection for private-sector loans to creditworthy buyers of exported U.s. goods and services.)
4. Preliminary commitments (supporting bids in foreign countries)
5. Political and commercial insurance (provides protection against losses from political and commercial risks)

Question 29

What are the three restrictions when applying for services from Eximbank?

Answer 29

1. at least 51% American
2. no armaments
3. must be environmentally friendly

Question 30

What is Private Export Funding corporation?

Answer 30

Eximbank fully guarantees repayment of all PEFCO obligations.
It mobilize private capital for financing the export of big-ticket items by U.s. firms. It purchases the medium- to long-term debt obligations of importers of U.S. products at fixed interest rates.

Question 31

What is a letter of credit?

Answer 31

1. A letter addressed to seller
2. written and signed by buyer’s bank
3. promising to honor seller’s drafts
4. Bank substitutes its own commitment
5. Seller must conform to terms