UNIT 3

FINANCING INTERNATIONAL TRADE

Brief discussion questions

1. What are some of the risks involved in trading internationally?

2. What payment methods do you know that are used when exporting or importing goods?

3. What is the role of the banks in international trade?

2

What are some of the risks involved in trading internationally?

3

Suggested answer

Risk of not being paid (for the

exporter) Risk of not receiving goods (for the

importer) Risk of receiving goods which are

different from those ordered or of lower quality or in a damaged condition

Risk of force majeure (Eg: storms, disasters etc.)

4

What payment methods do you know that are used when exporting or importing goods?

5

Suggested answer

Open account Document credit Bills for collection Advance payment

6

What is the role of the banks in international trade?

7

Suggested answer

Active role: When the Banks get involved in the payment process, supporting both the exporter and the importer to complete their obligations so that the contract is carried out as agreed. For example, in the documentary credit method of payment.

8

Suggested answers

Passive role: When the bank only do things as requested. For example, just transferring money to the account of the seller/exporter.

9

Open account

Is only used for transactions between exporters and importers which have already established a trust-worthy and long-term business relation.

Saving time for both exporter and importer as they deal directly with each other – not much involvement of banks.

10

Documentary Letter of credit

• A document issued by a bank, whereby the bank replaces the buyer as the paying party. The exporter is basing his risk of getting paid on the bank rather than on the importer. The bank will have to be reimbursed by the importer.

Some of the Documents Called for under a LC

• Financial Documents: Bill of Exchange, Co-accepted Draft

• Commercial Documents: Invoice, Packing list• Shipping Documents: Transport Document, Insurance

Certificate, Commercial, Official or Legal Documents

• Official Documents: License, Embassy legalization, Origin Certificate, Inspection Cert , Phyto-sanitary Certificate

• Transport Documents: Bill of Lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt

• Insurance documents: Insurance policy, or Certificate but not a cover note.

Irrevocable LC

• A letter of credit that cannot be canceled nor amended without agreement of all parties

Revocable LC

• A letter of credit that may be canceled at any moment without prior notice to the beneficiary

Sight & Time Letter of Credit

• If payment is to be made at the time of presenting the document then it is referred as the Sight Letter of Credit. In this case banks are allowed to take the necessary time required to check the documents.If payment is to be made after the lapse of  a particular time period as stated in the draft then it is referred as  the Term Letter of Credit.

16

Deferred payment LC

• A letter of credit under which the documents are forwarded to the importer’s bank, while sight draft is presented at a latter future date

Red clause LC

• A letter of credit permitting the beneficiary to receive a sum prior to shipment

Transferable LC

• A letter of credit that can be utilized by someone designated by the original beneficiary

Revolving LC

• A letter of credit calling for renewed credit to be made available when the issuing bank informs the beneficiary that the buyer has reimbursed the issuing bank for the drafts already drawn

Back to back LC

• Two letter of credit with identical documentary requirements, except for the difference in the price as shown by the invoice and draft

Traveler LC

• A letter of credit issued by a bank, addressed to all its correspondents, permitting the bearer to draw drafts up to the total amount named in the letter

Standby LC

• A letter of credit that can be drawn against, but only if another business transaction is not performed

Bid or performance bond

• A financial guarantee, given by a contracting company, which states that it has the capability to start and satisfactorily complete the project

Advised LC

• A letter of credit issued by a bank and forwarded to the beneficiary by a second bank in his area. The second bank validates the signatures and attests to the legitimacy of the first bank

Confirmed LC

• A letter of credit issued by one bank to which a second bank adds its commitment to pay

Documentary credit

Being used worldwide Safer for exporter as it makes sure

he will get his money for the goods sold provided that he presents the correct documents

Ensure the importer that he will get the goods bought as long as he pays for them or agreed to pay in a fixed date in the future.

Greatly supportive involvement of banks in the transaction process.

Taking more time than other methods of payment

27

Look at the 2 diagrams below to explain how a letter of credit works

28

29

30

Bills for collection

Clean collection: more risky as the importer can use the documents of the title to receive the goods only by agreeing to pay in a fixed date in the future

Documentary collection: safer as the importer has to pay in return of the documents of title to receive the goods after all.

More passive roles of the banks. They only do what is required.

31

• Documents Against Payment  D/P• In this case documents are released to the importer

only when the payment has been done. • Documents Against Acceptance  D/A• In this case documents are released to the importer

only against acceptance of a draft.

32

Advance payment

Safest for the exporter if the importer has to fully pay for the good bought in advance

Still safe if the importer pays in part in advance

Time saving Being used if there is more demand

than supply for that kind of commodity.

33

Conclusions about each method of payment mentioned above.

38