Lecture 13
Financing International Trade
Important Information
• Last Exam:
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Wednesday, December 3rd
150 points
Chapters 11, 12, 13, 15, 18, 19, and 23
Lecture 1 – 13
Research papers (general themes)
• Review Session:
– Monday, December 1st
• Office Hours:
– Tuesday: 1 – 3 (No office hours the rest of the week)
Definition
• Import or export transaction: a contractual
exchange involving goods/services for
money between parties in two countries
that may have:
– different legal systems,
– currencies,
– cultures
Viewing International Trade
Finance Issues
Financing Trade: The Flow of Goods and the Flow of Funds
Domestic Supplier
(US)
Goods &
Services
Flow from
Supplier to
Trident to
Buyer
Domestic Buyer
(US)
IMPORTING
Mexican Supplier
Mexican
Pesos
US$
Trident Corp.
(Los Angeles)
US$
Canadian $
Goods &
Services
Flow from
Supplier to
Trident to
Buyer
EXPORTING
Canadian Buyer
Two Issues Facing Firm
• Foreign Exchange Exposure:
– Importing (Accounts Payable)
• Problem if the foreign currency strengthens
• Hedge with a forward purchase
– Exporting (Accounts Receivable)
• Problem if the foreign currency weakens
• Hedge with a forward sale
• Risk of Default
– Not receiving goods ordered/paid for!
– Not receiving payments for goods shipped/sold!
International Trade Risks: Exporter
The Trade Transaction Timeline
Time and Events
Price
Export
Goods
Documents
Goods
Cash
Quote
contract
are
are
are
settlement
request
signed
shipped
accepted
received
of the
transaction
Negotiation
Production
Documents are
presented
Financing Period
International Trade Possibilities
• International trade takes place between three
categories of relationships:
– affiliated parties (subsidiaries of parent)
– unaffiliated unknown parties
– unaffiliated known parties
• Trade transactions between affiliated parties
typically do not require contractual
arrangements or external financing.
• Trade transactions between unaffiliated parties
typically do require contractual arrangements as
well as some type of external financing such as
letters of credit
International Trade Finance
Trident as an Exporter
Importer is…
Unaffiliated Unknown
Party
This is a new customer
which Trident has no
historical business
relationship with
Unaffiliated Known
Party
This is a Long-term customer
with which there is an
established relationship of
trust and performance
Affiliated Party
This is a foreign subsidiary
of Trident, a business unit of
Trident Corporation
Requires:
Requires:
Requires:
1.
A contract
1.
A contract
1.
No contract
2.
Protection against
non-payment
2.
Possible protection
against non-payment
2.
No protection
against nonpayment
Basic Elements of an
Import/Export Transaction
• Each individual export sales transaction covers three
basic elements:
– The Contract: description of goods (quantity, grade, quality,
technical details, payment instructions).
– Prices (do they include shipping charges insurance fees), and
– Documents regarding shipping and delivery instructions. These
include:
• Bills of lading (B/L) – is issued to the exporter by a common
carrier transporting the merchandise
• Commercial invoice – is issued by the exporter and contains a
precise description of the merchandise. Unit prices, financial terms
of sale, and amount due from the importer are indicated such as
“FOB” (free on board), “FAS” (free alongside), “CFR” (cost &
freight), or “CIF” (cost, insurance, freight)
Still More Documents
– Insurance documents – must be as specified in the
contract of sale and must be issued by insurance
companies or their agents.
– Consular invoices – issued in the exporting country
by the consulate of the importing country to provide
customs information and statistics for that country and
to help prevent false declarations of value
– Packing lists – may be required so that the contents
of containers can be identified, either for customs
purposes or for importer identification of the contents
of separate containers
Additional Elements of an
Import/Export Transaction
• Shipping deadline – most importers insist on a
specified deadline or time interval by which the shipment
will be made
• Payment instructions – which of the parties, exporter
or importer, is to pay such charges as freight, insurance,
import duties, handling fees, taxes, etc., must be
carefully specified in the sales contract
• Packaging and marking – depending on the nature of
the goods, proper packaging may be critical to
preserving and protecting items being shipped
• Warranties, Guarantees, and inspection – assurances
regarding the performance or qualities demonstrated by
the goods from the exporter may also be included in the
sales contract
Financing Trade Sales
• Over many years, established procedures have arisen to
finance international trade.
• The basic procedure rests on the interrelationship
between three key documents:
– The letter of credit (L/C)
– The draft, and
– The bill of lading
• Variations in each type of these three documents provide
a variety of ways to accommodate any type of
transaction
Financing Trade Sequence
• In the simplest transaction, in which all three documents
are used, an importer applies for and receives a L/C
from its bank
• In the L/C, the bank substitutes its credit for that of the
importer and promises to pay if certain documents are
submitted to the bank. The exporter may now rely on
the promise of the bank rather than that of the importer
• The exporter typically ships on an order bill of lading, i.e.,
attaches the bill of lading to a draft ordering payment
from the importer’s bank and presents these documents,
plus any additional documents, through its own bank to
the importer’s bank
Letter of Credit
• Letter of Credit (L/C) is a bank’s conditional promise to pay. Issued
by a bank at the request of an importer in which the bank promises
to pay an exporter upon presentation of documents specified in the
L/C
• The essence of an L/C is the promise of the issuing bank to pay
against specified documents, which means that certain elements
must be present for the bank
– Issuing bank must receive a fee for issuing L/C
– Bank’s L/C must contain specified maturity date
– Bank’s commitment must have stated maximum amount
– Bank’s obligation must arise only on presentation of specific
documents
– Bank’s customer must have unqualified obligation to reimburse
bank on same condition of bank’s payment
A Draft
• A draft, sometimes called a bill of exchange (B/E), is the
instrument normally used in international commerce to
effect payment
– It is a written order by an exporter instructing an
importer or its agent to pay a specified amount at a
specified time
– The party initiating the draft is the maker, drawer, or
originator while the counterpart is the drawee
– In a commercial transaction where the buyer is the
drawee it is a trade draft, or the buyer’s bank when it
is called a bank draft
Banker’s Acceptances
• If the documents are in order, the importer’s bank either
pays the draft (sight draft) or accepts the draft (time
draft). In the latter case, payment is at a future date.
• At this step the importer’s bank acquires title to the
merchandise through the bill of lading and releases it to
the importer against a promise to pay
• If a sight draft is used, the exporter is paid at once, if a
time draft is used the exporter receives the accepted
draft, now called a banker’s acceptance, back from the
bank and holds it until maturity or sells it at a discount
Bankers’ Acceptance
• Banker’s Acceptance
– When a draft is accepted by a bank, it becomes a
banker’s acceptance
– Example: Acceptance of $100,000 for exporter
Face amount of acceptance
$100,000
Less 1.5% p.a. commission for 6 months
-
Amount received by exporter in 6 months
$ 99,250
Less 7% p.a. discount rate for 6 months
-
Amount received by exporter at once
750
3,500
$95,750
– Exporter may discount the acceptance note in order
to receive the funds up-front
Bill of Lading
• Bill of Lading (B/L) is issued to the exporter by a
common carrier transporting the merchandise
– It serves the purpose of being a receipt, a contract
and a document of title
• As a receipt the B/L indicates that the carrier has
received the merchandise
• As a contract the B/L indicates the obligation of the
carrier to provide certain transportation
• As a document of title, the B/L is used to obtain
payment or written promise of payment before the
merchandise is released to the importer
Protection of Parties
• The three key documents noted in the previous slides
have been crafted over time to protect all parties
involved in a trade transaction.
• These documents serve to determine who bears the
financial loss if one of the parties defaults at any time
– Risk of non-completion – once both parties agree to
terms, they each want assurance that other party will
complete its portion of the transaction
– Financing the trade – some is required typically so
parties must secure financing through a bank which
acts as an intermediary utilizing the three key
documents
Example of a Trade
Transaction
• Example: Assume Trident receives order from Canadian
buyer; Trident will export financed under L/C requiring a
bill of lading with exporter collecting a time draft
accepted by Canadian buyer’s bank
– The Canadian buyer places order with Trident
– Trident agrees to ship under L/C
– Canadian buyer applies to bank (Northland Bank) for
L/C to be issued in favor of Trident for merchandise
– Northland Bank issues L/C in favor of Trident and
sends it to Southland Bank (Trident’s bank)
Example of a Trade
Transaction
– Trident ships the goods to the Canadian buyer
– Trident prepares a time draft and presents it to
Southland Bank. The draft is drawn on Northland
Bank with required documents including bill of lading
– Trident endorses the order bill of lading in blank so
that title to goods goes with holder of documents –
Southland Bank
– Southland Bank presents draft and documents to
Northland Bank for acceptance, Northland accepts
and promises to pay draft at maturity – 60 days
Example of a Trade
Transaction
– Northland Bank returns accepted draft to
Southland Bank; Southland Bank could ask
for discounted draft receiving funds today
– Southland Bank, now having a banker’s
acceptance, may sell the acceptance in the
open market or it may hold the acceptance in
its own portfolio
– If Southland Bank had kept the acceptance, it
would transfer the proceeds less commission
to Trident
Example of a Trade
Transaction
– Northland Bank notifies Canadian buyer of
arrival of documents; Canadian buyer signs
note to pay Northern Bank for the
merchandise in 60 days
– After 60 days, Northland Bank receives
payment from Canadian buyer
– On same day, holder of matured acceptance
presents it for payment and receives it face
value; it may be presented at Northland Bank
or returned to Southland Bank for collection
through normal bank channels
Complete Trade Transaction
1. Canadian Buyer orders goods
Trident
(exporter)
2. Trident agrees to fill order
Canadian Buyer
(importer)
6. Trident ships goods to Canadian buyer
7. Trident
presents
draft &
documents
to its bank
11. Southland
pays Trident
12. Northland
obtains Canadian
buyer’s note and
releases shipment
13. Canadian
buyer pays
bank
8. Southland presents draft &
documents to Northland
Southland Bank
5. Southland
advises
Trident of the
L/C
Northland Bank
9. Northland accepts draft, promising to
pay in 60 days and returns acceptance to
Southland
4. Northland Bank sends L/C to Southland Bank
10. Southland sells acceptance
to investor
Public
Investor
14. Investor presents
acceptance for payment
3. Canadian
buyer arranges
L/C with bank
Government Programs to
Help Finance Exports
• Export Credit Insurance
– Provides assurance to the exporter or the exporter’s
bank that an insurer will pay should the foreign
customer default
– In the US the Foreign Credit Insurance Association
(FCIA) provides this type of insurance
• Export-Import Bank
– Known as the Eximbank, it facilitates the financing of
US exports through various loan guarantee and
insurance programs