INSTITUTE OF BANKERS IN MALAWI
MAY 2013 SOLUTIONS
SUJECT:
INTERNATIONAL TRADE FINANCE (IOBM-D202)
Question 1
(a)
Explain the main difference between the Heckscher -Ohlin Theory of Trade and Adam
Smith’s theory of Trade (5 Marks)
The Hecksher –Ohlin theory of trade explains comparative trade advantage between
countries in terms of opportunity cost theory which states that the cost of a
commodity is the amount of a second commodity that must be given up inorder to
produce one additional unit of the fist commodity. Thus a country with the lower
opportunity costs to produce a commodity has a comparative cost of production
advantage in that commodity. COUNTRIES THEREFORE SHOULD SPECIALISE IN THE
PRODUCTS FOR EXPORTS IN WHICH IT HAS PRODUCTION COSTS ADVANTAGE
Adam Smith argued that with free and voluntary trade countries could specialize in
the production of those goods and services in which they had an absolute advantage
over other nations. Thus the Hecksher- Ohlin Theory focuses on the diferrence in
relative factor endowments and factor prices between counties as the most important
driving force for trade
(b )
With the help of a diagram discuss the modus operandi of a typical documentary collection
( 10 marks)
Diagram pp 100 3 marks for the diagram
1. Buyer and seller conclude contract
2. The principal ships the goods to the drawee
3. The principal hands the documents to the remitting bank with instruction to release the
documents against payments owed or agaist acceptance of bill of exchange
4. The remitting bank forwards documents to the collecting bank in the drawees country
5. The collecting / presenting bank releases the documents to drawee as perinstructions
received from remitting bank
6. The buyer clears the goods
7. The collecting / presenting bank obtains payment from the drawee and effects payment
to the remitting bank for credit to the principals account.
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Question 2
(a)
Explain how exchange rates are quoted by giving examples ( 4 marks )
Direct and indirect quotation
Direct quotation expresses exchange rate as the price of foreign currency in terms of the
foreign currency MK 358: US $1.00
Indirect quotation expresses the the exchange rate as the price of the domestic currency eg
US$ 0.00358
( b)
Mention two ways in which a Central Bank can intervene in the foreign exchange market
(4marks)
Direct method – involves intervention by buying or selling currency in an attempt to
manipulate the market
Indirect method of intervention attempts to influence the exchange rate through changes in
the money supply.
(c)
Explain two risks faced by banks when dealing with foreign exchange ( 4marks)
Currency risk- Occurs when a bank does not cover or hedge currencies against adverse
exchange rate movements
Spot settlement risk- Occurs when settlements / confirmations are not done immediately
after concluding a transaction
(d)
Explain how a bank would mitigate the risks ( 3 marks )
Currency risks could be eliminated by utilizing forward contracts swap transactions or derived
Instruments
Settlement instructions to be effected immediately after conclusion of a deal.
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Question 3
(a)
Explain the following Contract Agreements in International Trade ( 10 marks )
(i)
ConsignmentIn a consignment agreement the exporter ships the goods to the importer, but the exporter
still remains the title holder of the goods until the importer has sold them and paid the
exporter. Contract made under arrangement where the exporter trusts the importer or
marketability of goods is uncertain.
(ii )
Counter- trade
Counter Trade refers to a variety of international trade agreements in which goods and
services are exported by a manufacturer with compensation linked to the agrrement that the
manufacturer will accepot imports of other goods and services , an export sale is tied by a
contract to import.
(iii )
Switch Trading
Involves transferring use of bilateral balances from one country to another, the purchase of a
third party of of one country’s clearing agreement imbalance for hard currency which in turn is
sold at a discount.
(iv )
Buy back or compensation transaction
A transaction that requires a reciprocal commitment, invoves a technological transfer via the
sale of the manufacturing plant. As part of the transaction the seller agrees to purchase a
certain portion of the plant output once it is constructed.
(v )
Simple barter
A direct exchange of physical goods between two trading partners where money does not
change hands, no money transfer is involved.
(b)
Explain why Malawi has Exchange Control Regulations affecting exports and how control over
exports is maintained? ( 5 marks)
The purpose of exchange control regulating exports is to ensure that export proceeds are received
in Malawi and that proceeds are received within two months of export.
Control over export proceeds is maintained though form CDI which must be duly endorsed by
authorized dealer bank before the export is cleared through customs and excise.
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Question 4
(b)
Explain three methods used for settlement of international trade transactions?
( 6 marks )
1. Bank Draft
A bank draft is a cheque issued by a domestic bank which is denominated in
foreign currency and is drawn on its account maintained outside the country.
The export presents this to his domestic bank which in turn gives him the local
currency equivalent or alternatively the exporter may deposit in a foreign
currency account.
2. SWIFT Message
SWIFT stand for Society for World wide Inter bank Financial
Telecommunications and is the most popular settlement method. It is the
most important communications network for international transfer payment
of funds utilized by almost all major banks.
3. Telex and cable message
This does not involve physical movement of cash or cheques but it is a
payment order in writing addressed by one bank to another instructing the
bank to which it is addressed to pay a sum certain in money to or on applicaton
by a specified person or beneficiary.
(c)
Explain two reasons why some countries apply exchange controls ( 4 marks)
Exchange controls are maintained in the hope that they help protect the
domestic currency and foreign exchange reserves.
Exchange controls are applied to provide stability by limiting exchange rate
volatility due to currency outflows.
(d)
Explain the impact of quotas and Tariffs on Trade ( 5 marks )
Import quotas are restrictions on the quantity of goods which may be imported and have the
effect of increasing the price of the good due to low supplies
Tarrifs are import duties and taxes imposed on imports and have the effect of increasing the
price of imports as well as contributing revenue to the importing country
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SECTION B 40 MARKS
ANSWER ANY TWO QUESTIONS FROM THIS SECTION
Question 5
(a )
What is an avarised Bill? ( 2 marks )
An avarised bill is where a bank or other party guarantees payment of a bill of exchange at
maturity. Avalisation is the act of adding of a banks name to a bill of exchange with the
intention of guaranteeing payment at maturity.
(b)
State the procedures involved in avarisation of bills ( 10 marks)
The bank that adds its aval to the bill of exchange becomes the guarantor
Avarised bills are used either where principal wants a guarantee that payment will be made at
maturity or wishes to discount the proceeds of a term of the bill of exchange.
Remitting bank must instruct the collecting bankto add its aval on the collection instructions
Collecting bank must not add its aval to a bill of exchange unless it has been accepted by the
drawee
The collecting bank can only legally enforce recourse if the bill of exchangeis accepted in terms
of the signing arrangements held.
The guarantor bank marks the value of the avalised bill of exchange against the drawees
credit facility
In some instances separate guarantees must be issued
(c)
Mention the main features of a bill of exchange ( 8 marks)
The tenor / maturity date of the bill of exchange must correspond with the terms and
conditions of the contract and the instructions on the collection schedule
The full name of the principal must be specified
The address of the principal
Currency and amount in words must agree
Full name and address of drawee
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Amount of bill of exchange must correspond with that of the commercial invoice and
collection schedule
The principal must sign the bill of exchange
The principal must endorse the bill of exchange
Question 6
(a)
Trade Mark Limited is your customer would like to purchase some machinery from ABC
Limited in Zambia. However ABC is questioning or doubting the creditworthiness of
your client. Explain how your bank would assist using a documentary credit ( 4 marks)
Trade Mark Limited would be advised to apply to the bank for a documentary credit
, which is an undertaking issued by a bank in favour of a beneficiary which substitutes
the applicants creditworthiness for that of the bank, a letter of instruction would be
issued by the bank to ABC Limited of Zambia to give a binding undertaking that if the
compliant documents are presented the bank will pay ABC Limited the amount due on
behalf of Trademark Limited.
(b)
ZATHU Limited would like to import tractors from Kimono Industrial Machines based in Japan
and would like to establish a letter of credit through your bank .State the procedures and
processes that the client and the bank would undertake to establish a Letter of Credit ( 14
marks)
7 STEPS AS PER PP117
1. Zathu Limited will place an import order with a foreign exporter and agree with Kimono
Industries of Japan that goods will be shipped under a letter of credit,
2. Upon agreement, Zathu Limited will apply to the bank to open a documentary credit in
favour of Kimono Industries. The bank will evaluate Zathu Limited’s creditworthiness as
well as making the necessary exchange control application for the establishment of the
Letter of Credit
3. The bank will issue the L/C and send it to Kimono Industries through an advising bank /
correspondent bank in Japan
4. Upon receipt of the L/C the advising/ correspondent bank will check the authenticity of
the L/C then notify Kimono Industries.
5. Kimono Industries will check whether the L/C matches commercial agreements and
satisfies all terms and conditions of the contract
6. After being convinced that the L/C meets the stipulated terms Kimono Industries will ship
the consignment to Malawi
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7. The Kimonos bank will present the shipping documents and a time draft to Zathu Limiteds
bank in Malawi
8. The Malawian bank ( issuing bank reimburses Kimonos bank immediately if it is a sight
L/C or forwards all required documents to Zathu Limited with a credit note for the full
amount plus commissions
(c)
Mention the main types of documentary credits ( 2 marks )
Irrevocable Letter of Credit- the issuing bank gives an irrevocable undertaking to
honour payment as long as the beneficiary complies with the credit terms
Revocable Letter of Credit – May be cancelled or amended at any time after issuance
without the prior consent or knowledge of the beneficiary.
Question 7
(a)
What is export finance (2marks)
Lending to exporters specifically to cover the gap between shipment of goods and the recept
of payment necessitated by the need by buyers for longer credit added to greater distances
involved which cause inevitable payment delays.
(b)
State the difference between pre shipment finance and post shipment finance ( 2 marks )
Pre-shipment finance is money required to finance the exporter between dispatch of goods
and receipt of payment. Pre-shipment finance is the money required to finance the business
between the commencement of the manufacturing process and the dispatch of goods by the
exporter.
(c)
What do the terms “with recourse” and “ without recourse” mean in trade finance ( 2 marks)
The Exporter is legally responsible for payment of money if finance is provided with recourse ,
without recourse means the lender has agreed to look to someone other than the exporter for
repayment
(d )
What is factoring? Mention two types of factoring ( 3 marks )
Factoring is the purchase of a debt for discount, the factor buys the book debts of a client
company for a price and arranges to pay the client company either when the debt is finally
paid or more often by paying a proportion of the invoice value immediately and the balance
less any expenses when the debt is collected.
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The two types of factoring are with recourse where the factor agrees to advance money to
client companies where there is no debt insurance and the client compay stands the credit
risk.
Without recourse factoring means that the factor agrees to provide debt insurance usually
100% of the invoice value.
(e )
What is forfeiting? Mention the risks a forfeiter takes ( 6 marks)
Forfaiting is the purchase by a bank of an exporters medium trade receivables evidenced by
Accepted Bills of Exchange or promisory notes, which the bank either retains for presentation
at maturity dates or sells to another bank in the fofait market.
Risks taken- Non payment risk-, political risk in the buyers country, transfer risk buyers
country not able to meet the foreign exchange obligations and foreign exchange risk.
Question 8
(a)
Define a demand guarantee and state its uses ( 4 marks)
A demand guarantee is an irrevocable written undertaking by an institution( the guarantor) on
behalf of a party for the payment of money on behalf of a part (principal)for the payment of
money on the presentation of a written demand for payment by another party ( the
beneficiary stating that the principal has defaulted in terms of the contract between them .
(b)
What are the main features of Uniform Rules for Demand Guarantees (6 marks)
The International Chamber of Commerce ( ICC) provides a standard set of rules which parties
may incorporate in their guarantee arrangements
Main features include the following;
-
Require the consent of all parties to the guarantee
-
Are independent from the underlying contract
-
Deal with documents only
-
Are not exhaustive
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(c)
-
Are intended for use with international transactions with parties based in different
countries
-
Cover all types of guarantees
Mention 5 types of Guarantees and their uses ( 10 marks )
Tender Guarantee- designed to ensure that the tenderer does not withdraw his tender before
adjudication or does not fail or refuse to the award of contract in its favour or does not fail or
refuse to furnish the performancy security in accordance with the instruction to the tenderers
Performance Guarantee- Assures payment to the employer in the event that the contractor
does not fulfill his obligation in terms of the underlying contract
Advance Payment Guarantee- Enables the employer to call the guarantee to get refund of
advance payments made in the event of default by the contractor
Shipping Guarantees- indemnities used to enable a buyer to obtain release of goods from the
carrier where the bills of lading are either missing or delayed.
Retention Money Guarantee- Allow for immediate release of retention money to the
contractor and enable employer to obtain a refund of retention money released to the
contractor in the event of default by the contractor
OTHERS
Maintanance Guarantee- ensure that the contractor does not abandon the works / contract
after completion of the construction phase, but continues to honour any maitanance
obligations as per contract terms.
Facility Guarantee- Provides security to another bank to advance money or mark a crdit
facility to a company or individual
Customs Guarantee- For goods that would be re exported eg trade exihibitions, construction
machinery or trade fair items.
Counter Guarantee- an undertaking by the counter guarantor to pay the guarantor in the
event of the guarantor having to honour a valid demand from a beneficiary.
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