TOPIC 4: MAJOR DOCUMENTS USED IN CREDIT TRANSACTIONS Flashcards
Are written documents or legal agreements that outline the terms and conditions of lending and borrowing, representing a promise by one party (the borrower) to repay a debt to another party (the lender) under specific terms.
CREDIT INSTRUMENTS
NATURE OF CREDIT INSTRUMENTS
- Legality and Formality
- Transferability
- Documentation of Debt
- Security for Lenders
- Conditionality
CLASSIFICATION OF CREDIT INSTRUMENTS
- As to Acceptability
- As to Form
- As to Function
- As to Negotiability
refers to how widely they are accepted and recognized by financial institutions, businesses, and the general public.
As to Acceptability
As to Acceptability
(a) Limited Acceptance
(b) Unlimited Acceptance
These are terms used in the context of credit instruments, particularly in trade and finance, to describe the terms under which a party agrees to honor a bill of exchange or similar financial document.
Limited acceptance and unlimited acceptance
refers to a situation where the drawee (the person or entity to whom the bill of exchange is directed) agrees to accept the bill, but only under certain conditions or for a portion of the total amount specified in the bill. The drawee does not accept the full terms of the bill as initially presented.
Limited Acceptance
Characteristics of limited acceptance
Conditional
Partial Acceptance
Geographical or Time-Based Limitations
occurs when the drawee accepts the bill of exchange or other financial instrument in full and without any conditions or limitations. The drawee agrees to pay the full amount specified and adheres to the terms and conditions as originally stated on the bill.
Unlimited Acceptance
Characteristics of unlimited acceptance
Full Acceptance
No Conditions
Straightforward Obligation
refers to the structure and appearance of the document and whether it is formal or informal.
As to Form
As to Form
(a) Order to Pay Instruments
(b) Promise to Pay Instruments
involve a directive from one party (the drawer) to another (the drawee) to pay a specified sum of money to a third party (the payee). These instruments typically include an unconditional order, where the drawee is instructed to make a payment on behalf of the drawer.
Order to Pay Instruments
A written order by one party (drawer) to another (drawee) to pay a certain sum of money to a third party (payee) on a specific future date or on demand. It is commonly used in trade transactions.
Bill of Exchange
A written order directing a bank (the drawee) to pay a specific sum from the account of the person who writes the cheque (the drawer) to the payee. These are commonly used in everyday banking and business transactions.
Cheque
The person who issues the order and instructs payment
Drawer
The entity (often a bank) that is ordered to make the payment
Drawee
The recipient of the payment
Payee
involve a direct commitment by one party (the maker) to pay a specified sum of money to another party (the payee) either on demand or at a future date.
promise to pay
A written, unconditional promise by one party (the maker) to pay a specified sum of money to another party (the payee) either on demand or at a fixed or determinable future date. These are widely used in lending agreements, including personal loans and business financing.
Promissory Note
An informal promise to pay, typically used between individuals, acknowledging a debt without formal legal terms. It may lack detailed repayment terms, making them less formal than promissory notes.
IOU (I Owe You)
The person or entity that issues the promise to pay
Maker
refers to how credit serves different roles or purposes in the economy.
As to function
As to function
(a) Productive Credit
(b) Consumer Credit
(c) Commercial Credit
(d) Investment Credit
(e) Development Credit
(f) Real Estate Credit
refers to loans or credit extended for investment in productive activities, typically aimed at generating income or profit. This type of credit is used to fund activities that contribute to the creation of goods and services, boosting economic activity and growth.
Productive credit
Loans used by companies to finance operations, acquire assets, or expand their business.
Business Loans
Loans provided to farmers for purchasing seeds, fertilizers, machinery, or to expand agricultural activities
Agricultural Credit
Credit extended to businesses for trading purposes, such as purchasing raw materials, inventory, or financing production.
Commercial Credit
credit extended to individuals to finance personal consumption or purchases of goods and services that do not directly generate income or wealth. This type of credit is used for buying durable goods (such as cars, appliances) or financing household expenses.
Consumer credit
A revolving credit line that consumers use to purchase goods and services, repayable over time with interest
Credit Cards
Loans taken by individuals for personal expenses such as home renovations, medical bills, or vacations.
Personal Loans
Loans used to purchase goods such as cars, electronics, or appliances, repaid over a fixed period with interest.
Installment Loans
refers to the credit extended to businesses or firms to facilitate commercial activities, such as trade, production, or services. It is typically used for short-term purposes to cover operational expenses or bridge cash flow gaps in business operations.
Commercial credit
A form of commercial credit where suppliers allow businesses to purchase goods or services on credit, with payment due at a later date.
Trade Credit
Loans used by businesses to finance short-term operational needs, such as paying suppliers or covering payroll.
Working Capital Loans
A financial guarantee used in international trade, where a bank ensures that a seller will receive payment from the buyer upon fulfillment of contractual terms.
Letter of Credit (LC)
is used for long-term investments, typically aimed at funding large projects, purchasing capital assets, or making significant financial investments. This type of credit is focused on generating future returns.
Investment Credit
Loans taken to purchase real estate properties, either for personal use or as an investment.
Real Estate Loans
Credit extended to fund large infrastructure projects like highways, bridges, or energy facilities.
Infrastructure Financing
Loans taken to invest in stocks, bonds, or other financial instruments, often with the aim of generating long-term returns.
Equity Financing
is aimed at funding economic development initiatives, typically in underdeveloped or developing regions. It is often extended by governments, financial institutions, or international organizations to fund projects that improve infrastructure, education, healthcare, and other critical sectors.
Development credit
Loans provided by international organizations like the World Bank to fund infrastructure projects, healthcare, or education in developing nations.
World Bank Loans
Small loans extended to low-income individuals or small businesses in developing areas to promote economic self-sufficiency.
Microfinance
Loans provided by governments to support regional development, especially in underdeveloped areas.
Government Development Loans
involves loans or credit used specifically for purchasing, developing, or refinancing property. It serves both individuals and businesses, helping them acquire or develop real estate for personal use, investment, or commercial purposes.
Real estate credit
Long-term loans used by individuals or businesses to purchase or refinance real estate, with the property serving as collateral.
Mortgage Loans
Loans used to finance the construction of residential or commercial buildings.
Construction Loans
Loans secured against the value of a person’s home, often used for renovations or other expenses.
Home Equity Loans
refers to the ability of these instruments to be transferred from one party to another, which impacts how they can be used in financial transactions.
As to Negotiability
As to Negotiability
(a) Negotiable Credit Instruments
(b) Non-Negotiable Credit Instruments
it determines whether a credit instrument can be easily endorsed, transferred, or sold in the secondary market.
Negotiability
financial instruments that can be transferred from one party to another, allowing the holder to claim the rights to payment or performance. These instruments are characterized by their ability to be easily endorsed, transferred, or sold, which enhances their liquidity and utility in commercial transactions.
Negotiable credit instruments
A written promise by one party to pay a specified sum to another party either on demand or at a fixed future date. They can be endorsed and transferred.
Promissory Notes
A written order by one party (the drawer) directing another party (the drawee) to pay a specified sum to a third party (the payee). These can also be endorsed.
Bills of Exchange
An order directing a bank to pay a specified sum from the drawer’s account to the payee.
Cheques
Securities that are payable to the holder, meaning whoever possesses the bond can claim payment. They can be transferred easily without formal endorsement.
Bearer Bonds
negotiable and can be transferred to another party, allowing the new holder to claim the deposit amount.
Certificates of Deposit (CDs)
are financial instruments that cannot be easily transferred or assigned to another party. The rights and obligations associated with these instruments remain with the original parties, and any transfer usually requires explicit consent from all involved parties.
Non-negotiable credit instruments
Informal acknowledgments of debt that are not typically transferable and do not convey rights to the holder.
IOUs (I Owe You)
Contracts that explicitly state they are non-negotiable or non-transferable, often seen in personal agreements or specific business contracts.
Certain Contracts
Contracts that explicitly state they are non-negotiable or non-transferable, often seen in personal agreements or specific business contracts.
Certain Contracts
Checks that indicate they are non-negotiable (usually stated on the check) cannot be transferred to another party.
Certain Types of Certificates of Deposit (CDs)
