Ch. 16 - International Trade Finance

3 natures of relationships/customers

1. Unaffiliated Unknown Party

2. Unaffiliated Known Party

3. Affiliated Party

Unaffiliated Unknown Party

New customer which company has no historical business

It requires:

1. A contract

2. Protection against nonpayment

Unaffiliated Known Party

A long-term customer with which there is an established relationship of trust and performance

It requires:

1. A contract

2. Possible some protection against nonpayment

Affiliated Party

A foreign subsidiary of a company, a business unit of a company

It requires:

1. No contract

2. No protection against nonpayment

Solutions as means of international payment

1. Letter of Credit

2. Bill of Lading

3. Sight Draft

Letter of Credit

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 L/C

• Reduces the risk of noncompletion because bank agrees to pay against documents rather than actual merchandise

Bill of Lading

Document that serves as title to the merchandise

Sight Draft

Document requesting payment

Benefits of the System

1. Protection against Risk of Noncompletion

2. Protection Against Foreign Exchange Risk

3. Financing the Trade

Protection Against Risk of Noncompletion

The letter of credit, bill of lading, and sight draft are part of a system carefully constructed to determine who bears the financial loss if one of the parties defaults at any time

Protection Against Foreign Exchange Risk

• If transaction requires payment in the exporter’s currency, the importer carries the foreign exchange risk

• Transaction exposure can be hedged

• The letter of credit, bill of lading, sight draft ensure both amount and time of payment, and thus lay the groundwork for effective hedging

2 risks of international trade

1. Currency Risk

2. Risk of noncompletion

Parties of a Letter of Credit

Beneficiary

• Exporter

Applicanta

• Importer

Issuing Bank

• Importer’s bank that issues a L/C

Elements of a true Letter of Credit

1. Issuing bank must receive a feee or other valid bsuiness consideration for issuing the L/C

2. Bank’s L/C must contain a specified expiration date or a definite maturity

3. The bank’s commitment must have a stated maximum amount of money

4. Bank’s obligation to pay must arise only on the presentation of specific documents, and the bank must not be called on to determine disputed questions of fact or law

5. Bank’s customer must have an unqualified obligation to reimbuse the bank on the same condition as the bank has paid