Export & Import Financing Chapter Twenty Eiteman, Stonehill, & Moffett April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Trade payment terms cash in advance draft bill of exchange letter of credit (L/C) bankers acceptance consignment open account April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Cash in advance Advantages least risky alternative risk is shifted entirely to the importer Disadvantages may be non-competitive, lose business preferred if goods made to order for purpose of financing the production April 16, 2017 Chapter 20 - Trade financing

Draft - bill of exchange issued and signed by the exporter (drawer) unconditional orders to pay (for the importer) on demand (sight draft) at a specified time in the future (time draft) fixes the amount of manner of payment time draft becomes an acceptance when accepted by drawee (exporter) L/C (promise of banker’s acceptance) draft (bill of exchange) accepted by bank April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Draft - types of drafts documentary drafts drafts which require supporting documentation bills of lading, invoices, etc. drafts accompanying trades are documentary non documentary (clean) non-commercial transactions April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Drafts - mechanics a draft extends credit receivable to the exporter payable to the importer exporter gives control of goods to importer for the signature on draft contract between exporter and importer only transferable (usually banker’s acceptances) at discount to bank, acceptance dealer rate lower than prime April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing L/C - terms promise of payment issued by the importer’s bank binds the importer’s bank to pay determining currency of payment timing of payment amount of payment binds the exporter to deliver a certain product quantity of goods quality of goods delivery date for goods April 16, 2017 Chapter 20 - Trade financing

L/C - advantages exporter reduces credit risk the bank’s reputation is on line reduces political risk banking system is tied into the political system reduces pre-shipment risk contracted terms for delivery of goods April 16, 2017 Chapter 20 - Trade financing

L/C - advantages importer reduces delivery risk contract stipulates delivery terms bank oversees custom’s procedures importer can contract for better terms exporter’s risk substantially reduced prepayment by importer goes to bank if the shipment is not satisfactory easier for importer to recover payment April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing L/C - types of L/Cs documentary L/Cs L/Cs which require supporting documentation bills of lading, invoices, etc. majority of L/Cs are documentary non documentary (clean) non-commercial transactions irrevocable L/C cannot be revoked except by mutual consent revocable (rarely used) better than nothing April 16, 2017 Chapter 20 - Trade financing

L/C - types of L/Cs con’t confirmed L/C by an other bank usually a bank in the exporter’s country obligates both banks to honor the obligation unconfirmed L/C- obligates issuing bank transferable L/C right to transfer, must be contracted transfer of L/C and supporting documents assignment assigning part of the proceeds to another party April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Banker’s acceptance acceptance of the draft by a bank bank substitutes its credit for importer’s credit if transferable - creates a negotiable instrument may discount this to the exporter resell in secondary markets terms maturities 30, 60, 90 days bank profits from fee on L/O, discount on acceptance April 16, 2017 Chapter 20 - Trade financing

Banker’s acceptance - hold PV of 1,000,000 usd less 2% annual commission less 9.7% wacc exporter gets BA and holds to term exporter hedges transaction exposure April 16, 2017 Chapter 20 - Trade financing

Banker’s acceptance - discount PV of 1,000,000 usd less 2% commission per annum less 10.4% discount per annum exporter gets BA and discounts exporter gets into exchange market now April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Mechanics of a trade few weeks after contract goods, price, quantity, quality production of goods financed by increase in input inventories, by payables labor inputs by accruals result an increase in output inventories payables, accruals must be paid payment financed by short-term financing April 16, 2017 Chapter 20 - Trade financing

Mechanics of a trade - con’t goods shipped output inventories still carried as assets goods, bill of lading, draft sent L/C sent to exporter delivery of goods goods, bill of lading, draft at customs time draft accepted by importer (acceptance) by importer’s bank (bankers acceptance) output inventories now change to receivables April 16, 2017 Chapter 20 - Trade financing

Mechanics of a trade con’t Banker’s acceptance may be transferable can be held by exporter for payment receivable stays on exporters books payable stays on importers books must hedge transaction exposure if it exists Banker’s acceptance if transferable can be discounted sold at discount to a bank or broker then receivable becomes cash payable still on importers books April 16, 2017 Chapter 20 - Trade financing

Mechanics of a trade con’t Risk if BA discounted foreign exchange exposure exists from time contract agreed to until draft is accepted by the importer’s bank BA signed credit risk higher until draft accepted (BA signed) lower until BA discounted April 16, 2017 Chapter 20 - Trade financing

Mechanics of a trade con’t Risk if L/C held to maturity foreign exchange exposure exists from time contract agreed to L/C matures credit risk higher until draft accepted (L/C issued) lower until L/C matures April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Consignment exporter retains title to good shipped importer gains possession, but not title very risky easy for importer to default on this type of arrangement terms whatever the importer sells is paid for goods not sold returned April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing open account most flexible importer receives goods - a payable acceptance by importer sufficient reduces bank charges risky - no bank guarantee on payment importer and exporter need to have a good stable relationship April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Documents of trade bill of lading B/L contract between exporter and carrier straight B/L - consigns good to importer order B/L - transferable often serves as collateral for L/C on board B/L - on board being shipped received-for-shipment B/L received, but not shipped clean B/L - goods(externally) look undamaged April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Other documents commercial invoice full description of merchandise insurance open (floating) prearrangement with insurer to cover shipments made requires an insurance certificate which must conform to information on B/L consular invoice April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Factoring firms that buy a firm’s receivables at discount non-recourse basis - factor assumes all risk recourse - exporter assumes risk factoring fees can run from 1.75 to 2 % per month compounded from 23.14 to 26.82 % per year on top of this non-recourse fees can add to this April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Export financing export-import banks finance exports of goods and services subsidy to try to create new markets for exports these are not market driven very bureaucratic & often political export-credit insurance low cost credit insurance lowers the cost of borrowing by reducing risk April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Countertrade barter direct exchange of goods between two parties counter purchase - parallel barter continued sale and purchase of goods Finland frequently sold manufactured goods for raw materials (oil) with the former Soviet Union buyback repayment of exports made by the sale of related product April 16, 2017 Chapter 20 - Trade financing

Chapter 20 - Trade financing Payment terms evolving instruments of international trade these instruments and methods are used to facilitate trade by exploiting comparative advantage reduce risk who how much its cost April 16, 2017 Chapter 20 - Trade financing