Topic 2: Financing Foreign Trade

Reference: EPS - International Banking and Finance, FTU

A. TERMS, THEORIES AND DEFINITIONS                             

1. Payment Terms in Foreign Trade

            a) Four Principal Means:

                        1.         Cash in advance

                        2.         Letter of Credit

                        3.         Drafts

                        4.         Open Account

            b) Cash in Advance

                        1.         Minimal risk to exporter

                        2.         Used where there is

                                    a.         Political unrest

                                    b.         Goods made to order

                                    c.         New unfamiliar customer

           
c) Letter of Credit (L/C)

                        1.         A letter addressed to seller

                                    a.         written and signed by buyer’s bank

                                    b.         promising to honor seller’s drafts.

                                    c.         Bank substitutes its own commitment

                                    d.         Seller must conform to terms

                        2.         Advantages of an L/C to Exporter

                 a.         eliminates credit risk

                 b.         reduces default risk

                 c.         payment certainty

                 d.         prepayment risk protection

                    e.         financing source

     3.         Advantages of L/C to Importer

                 a.         shipment assured

                 b.         documents inspected

                 c.         may allow better sales terms

                 d.         relatively low-cost financing

                 e.         easy cash recovery if discrepancies       

     4.         Types of L/Cs

                 a.         documentary/non-documentary

                 b.         revocable/irrevocable

                 c.         confirmed

                 d.         transferable

d) Draft

                        1.         Definition:

                                    - unconditional order in writing

                                    - exporter’s order for importer to pay

                                    - at once (sight draft) or

                                    - in future (time draft)

          2.         Three Functions of Drafts

                      a.         clear evidence of financial obligation

                      b.         reduced financing costs

                      c.         provides negotiable and unconditional financial instrument

                                  (i.e.  may be converted to a banker’s acceptance)

          3.         Types of Drafts

                      a.         sight

                      b.         time

                      c.         clean (no documents needed)

                      d.         documentary

e) Open account     

                        1.         Creates a credit sale

                        2.         To importer’s advantage

                        3.         More popular lately because

                                    a.         major surge in global trade

                                    b.         credit information improved

                                    c.         more global familiarity with exporting.

                        4.         Benefits of Open Accounts:

                                    a.         greater flexibility in making

                                                a trade

                                    b.         lower transactions costs

                        5.         Major disadvantage:

                                    - Highly vulnerable to government currency controls.

2. Documents used in Foreign Trade

Three most used documents

            a)         Bill of Lading

                        Three functions:

                                    1.         Acts as a contract to carry the goods.

                                    2.         Acts as a shipper’s receipt

                                    3.         Establishes ownership over goods if negotiable type.

   b)         Commercial invoice

               Purpose:

                 1.         Lists full details of goods shipped

                 2.         Names of importer/exporter given

                 3.         Identifies payment terms

                 4.         List charges for transport and insurance.

   c)         Insurance

                 1.         Two Categories:

                             a.         Marine: transport by sea

                             b.         Air:  transport by air

                 2.         Insurance Certificate

                             issued to show proof of insurance

                 3.         All shipments insured today.

3. Financing techniques

               Four Types:

                          1.         Bankers’ Acceptances

                                      a.         Creation: drafts accepted

                                      b.         Terms:  Payable at maturity to holder

            2.         Discounting

                        a.         Converts exporters’ drafts to cash minus interest to maturity and             commissions.

                        b.         Low cost financing with few fees

                        c.         May be with (exporter still liable) or without recourse(bank takes liability for nonpayment).

            3.         Factoring

                        -firms sell accounts receivable to another firm   known as the factor.

                        a.         Discount charged by factor

                        b.         Non-recourse basis:  Factor

                                    assumes all payment risk.

                        c.         When used:

                                    1.)        Occasional exporting

                                    2.)        Clients geographically dispersed.

            4.         Forfaiting

                        a.         Definition:

                                    discounting at a fixed rate without recourse of medium-term accounts       receivable denominated in a fully convertible currency.

                        b.         Use: Large capital purchases

                        c.         Most popular in W. Europe

B. VOCABULARY EXERCISES

Match these terms with their definitions. Example: 1 b

1. invoice 2. clean collection 3. documentary collection 4. bill of exchange 5. bill of lading 6. document of title 7. issuing bank 8. collecting bank 9. confirming bank 10. letter of credit

a. document that shows details of goods being transported; it entitles the receiver to collect the goods on arriveal b. list of goods sold as a request for payment c. bank that issues a letter of credit (i.e. the importer’s bank) d. bank that receives payment of bills, etc. for their customer’s account (i.e. the exporter’s bank) e. document allowing someone to claim ownership of goods f. payment by bill of exchange to which documents are not attached g. signed document that orders a person or organization to pay a fixed sum of money on demand or on a specified date h. bank that confirms they will pay the exporter on evidence of shipment of goods i. method of financing overseas trade where payment is made by a bank in return for delivery of commercial documents, provided that the terms and conditions of the contract are met j. payment by bill of exchange to which commercial documents (and sometimes a document of title) are attached.

C. READING

Open Accout

The goods, and relevant documents, are sent by the exporter directly to the overseas buyer, who will have agreeed to remit payment of the invoice back to the exporter upon arrival of the documents or within a certain period after the invoice date. The exporter loses all control of the goods, trusting that payment will be made by the importer on accordance with the original sales contract.

Documentary Credit

 Documentary Credit is often referred to as a Letter of Credit. This is an undertaking issuing by an oversea bank to a UK exporter through a bank in the UK, to pay for the goods provided that the exporter complies fully with the conditions established by the Documentary Credit.

Additional security can be obtained by obtaining the “comfirmation” of a UK bank¹ to the transaction, thereby transferring the responsibilities form the importer’s bank overseas to a more familiar bank in the country of the exporter.

Very few risks arise for the exporter because the potential problem areas of the buyer risk and country risk can be eliminated. However, the exporter must present the correct documents and comply fully with the terms and conditions of the credit. Failure to do so could result in the exporter losing the protection of the credit.

Bills for Collection

Trade collections are iniitiated when an exporter draw a bill of exchange on an overseas buyer. This is fowarded by the exporter’s bank in the importer’s country. Such collections may be either “documentary” or “clean”². A documentary collection is one in which the commercial documents and, if appropriate, the documents of title to the goods are enclosed with the bill of exchange. These are sent by the exporter’s bank to a bank in the importer’s country together with instructions to release the documentation against either payment (D/P) or acceptance (D/A) of the bill.

The risks that the exporter has to face are that the importer fails to accept the bill of exchange or dishonours an accepted bill³ upon maturity. This means that the exporter may have to consider shipping the goods back to the UK, finding an alternative buyer or even abandoning the consignment, all of which could be expensive.

In many areas of the world it is common practice to defer presentation⁴, payment or acceptance until arrival of the carrying vessel. Collection and remittance charges can also be relatively high.

If the exporter retains control over the goods by remitting a full set of Bills of Lading⁵ through the intermediary of the banking system, control of the goods will be handed over to the importer only against payment or acceptance of the bill, control of the goods is lost and the acceptance bill of exchange may be dishonoured at maturity.

Advance Payment

Exporters receive payment from an overseas buyer in full, or in part, before the goods are dispatched. This means that the exporter has no risks associated with non – payment.

Notes:

1. This bank is then known as the confirming bank.

2. Clean means that no documents are involved.

3. The importer does not pay, although he had previously agreed to pay.

4. This means to delay passing the bill to the importer.

5. This means sending all the necessary shipping documents.

D. READING COMPREHENSION EXERCISES

1. Write the four methods of payment in the correct positions according to their risks for the exporter.

Least secure ---------------------------------------------------------à Most secure

(1) Open account à(2)................ à(3)..................... à (4)..................................

2. Mark these statements T (true) or F (false) according to the information in the text.

Open account

a) The importer pays for the goods after receiving the documents. T

b) There is no contract involved.

c) The exporter must be able to trust the buyer.

Documentary Credit

d) If a letter of credit is issued, the importer’s bank agrees to pay for the goods without conditions.

e) If a letter of credit is confirmed, the exporter’s bank takes responsibility for payment.

Bills for collection

f) Commercial documents and the document of title are always enclosed with a bill of exchange.

g) Importers may not accept the bill of exchange untill the goods arrive.

h) Exporters can keep control of goods by sending bills of exchange through the banking system.

i) Exporters reduce risk if documents are released against acceptance of the bill rather than payment.

Advance payment

k) This means that the importer has to pay before any goods are dispatched.

3. Find a word or phrase in the text that has the meaning of:

a) promise or guarantee given to or by a bank (paragraph 2): u....................

b) load of goods sent to a customer (paragraph 7): c........................

c) person or company that acts as a middleman in a transaction (paragrph 9): i.................

d) date when a bill of exchange is due for payment (paragraph 9): m..................

4. Complete the sentences with the words given

draw     accept     dishonour      release     remit      forward      dispatch     present

a) The first step the exporter takes is to ask his bank to ......draw......a bill of exchange on the overseas buyer.

b) The exporter’s bank ....................the bill of exchange, together with the commercial documents, to the importer’s bank.

c) At the same time, the exporter ...................the goods.

d) The exporter must take care to ..................the correct documents to the bank.

e) When the importer .......................the bill of exchange, the bank will ....................the documents of titles to the goods.

f) If the importer .......................the bill, the exporter may have to find an alternative buyer or ship the goods back again.

g) In some parts of the world, banks may be slow to ....................payment to the exporter’s bank.

E. GUIDE

1.

Open account à Bills for collection à Documentary Credit à Advance payment

2.

a)	b)	c)	d)	e)	f)	g)	h)	i)	k)
T	F	T	F	T	F	T	T	F	T

3. a) undertaking b) consigment c) intermediary d) maturity

4. b) forwards c) dispatches d) present e) accepts, release f) dishonours g) remit

F. FURTHER STUDY

Reading:

http://www.export.gov/tradefinanceguide/eg_main_043221.asp

Watching:

Letter of Credit