Slides prepared by April Knill, Ph.D., Florida State University Chapter 18 Financing International Trade

© 2012 Pearson Education, Inc. All rights reserved.18-2 Exhibit 18.1 An Example of the Fundamental Problem in International Trade

© 2012 Pearson Education, Inc. All rights reserved The Fundamental Problem with International Trade It takes time to ship goods to different countries –Either the importer or exporter must engage in some method of financing –Legal complexities arise, e.g., collecting delinquent accounts Differences in language, culture, accounting standards, etc. Who is a good credit risk? –Methods of financing Retained earnings Bank loans Issuing securities Advanced payments from importers –Terms differ depending on relative power of importer/exporter

© 2012 Pearson Education, Inc. All rights reserved International Trade Documents Bill of lading – a contract issued to an exporter of goods by the shipping company (a.k.a. “common carrier”) –Documents that the exporter’s goods have been received by the carrier –Describes the kind and quantity of goods being shipped –Who the shipper is –Who the importer is –Ports of loading and discharge –The carrying vessel –Costs of shipping

© 2012 Pearson Education, Inc. All rights reserved.18-5 Exhibit 18.2 Documents of International Trade

© 2012 Pearson Education, Inc. All rights reserved International Trade Documents Types of bill of lading –Negotiable bill of lading – most common –Straight bill of lading – carrier has received goods –Order bill of lading – used in case where transfer of title to goods is desired or if some form of third-party financing is desired –On-board bill of lading – indicates goods have been placed on a particular vessel for shipment –Received-for-shipment bill of lading – the merchandise is at the dock awaiting transport –Clean (vs. foul) bill of lading – the carrier believes the merchandise was received in good (vs. damaged) condition

© 2012 Pearson Education, Inc. All rights reserved International Trade Documents Commercial invoices – given by exporter to importer detailing merchandise including price and number of items Packing lists – list containing a description of goods in container Insurance – document listing insurance company insuring contents and its agents or underwriters; can be specific to item or open, which covers all items they ship for the company

© 2012 Pearson Education, Inc. All rights reserved International Trade Documents Consular invoice – provides information to customs officials in the importing country to prevent false declarations of value of merchandise; sometimes combined with a certificate of origin, which indicates the source of the goods Certificate of analysis – sometimes required to assure an importer that a shipment meets certain standards of purity, weight, sanitation or other measurable characteristic

© 2012 Pearson Education, Inc. All rights reserved Methods of Payments Cash in advance Documentary credits (D/Cs) – resolves the issue that importers and exporters want to pay and be paid at different times; involves a commercial bank Drafts – written order by the bank to pay the exporter –Sight draft –Time draft – once banker accepts, it becomes a “banker’s acceptance (B/A)”

© 2012 Pearson Education, Inc. All rights reserved Exhibit 18.3 A Documentary Credit (D/C)

© 2012 Pearson Education, Inc. All rights reserved Exhibit 18.4 An Example of a Time Draft

© 2012 Pearson Education, Inc. All rights reserved Methods of Payments Advantages of Documentary Credits to exporters 1.Substitutes the creditworthiness of the bank for the credit risk of the importing firm 2.Enhances the probability that the exporter will not experience delays in payment due to the imposition of foreign exchange controls or other political risks 3.Reduces the uncertainty of a transaction by clearly establishing the acts that the exporter must carry out in order to receive payment 4.Protects the exporter if the importer desires to cancel the contract during the production process 5.makes it easy for an exporter to receive early payment because a time draft can be accepted by the bank, which creates a banker’s acceptance

© 2012 Pearson Education, Inc. All rights reserved Methods of Payments Advantages of Documentary Credits to importers 1.Clearly indicates a time frame by which the goods must be shipped 2.The importer’s bank assumes responsibility therefore the importer is protected from having to pay for goods that are not valuable 3.It substitutes the bank’s credit standing for the importer’s credit standing, which means that the importer may be able to command better payment terms 4.If some form of prepayment is required by an exporter, an importer is better off depositing money in an escrow account at its domestic bank than with a foreign company. If the exporter encounters some difficulty that limits its ability to follow through on its contractual commitments, the importer can recover its deposit from a local bank more easily than it could from the foreign exporter.

© 2012 Pearson Education, Inc. All rights reserved Methods of Payments Attributes of Documentary Credits –Revoacable D/C – provides no guarantee of payment –Irrevocable D/C – cannot be revoked unless all parties, including the exporter, agree to it Used in cases where parties do not know each other well –Confirmed D/C – a 2 nd commercial bank (from exporter’s country) agrees to honor the draft 1 st bank is usuall from the country of the importer –Most secure type of D/C is irrevocable confirmed

© 2012 Pearson Education, Inc. All rights reserved Exhibit 18.5 Exporting with a Documentary Credit (D/C) and a Banker’s Acceptance (B/A)

© 2012 Pearson Education, Inc. All rights reserved Methods of Payments Documentary collections –The exporter retain control of goods until the importer has paid or is legally bound to pay for them –The exporter gets banks involved in the collection process, although the degree of responsibility banks bear for assuring payment is not as high as with a confirmed D/C Payment should be collected by documents against payment (D/P) collection or a documents against acceptance (D/A) collection Trade acceptance means importer acknowledges his legal obligation to pay at terms in contract – usually 30, 60, or 90 days later

© 2012 Pearson Education, Inc. All rights reserved Methods of Payments Advantages of documentary collections to exporter –Enforceable debt instrument –Can sell in short-term money market –Often paid more promptly with this documents –Transaction costs are lower than expenses in establishing a documentary credit Disadvantages of documentary collections to exporter –Banks are not obliged to pay so exporters bear risk –Deal may break down if importer refuses to take ownership –Exporters must bear political risk of importer’s country

© 2012 Pearson Education, Inc. All rights reserved Methods of Payments Sales on open account –Most risk to exporter –Allows importer to pay whenever – no arranged structure in payment time frame –Incentive for timely payment though in the way of a discount –Used primarily between related affiliates of same MNC or when a long relationship exists between importer/exporter

© 2012 Pearson Education, Inc. All rights reserved Financing Exports Bank line of credit Banker’s acceptances –Clean – without underlying documentary credit –Eligible (vs. ineligible) – does not have to (must) maintain reserves against the proceeds of the sale Buyer credit – exporter arranged credit for importer Selling accounts receivable Limited-recourse financing: forfaiting

© 2012 Pearson Education, Inc. All rights reserved Exhibit 18.6 Methods of Export Financing

© 2012 Pearson Education, Inc. All rights reserved Financing Exports Mechanics of forfaiting 1.Exporter and importer agree on a commercial transaction that covers a fixed interval of time 2.The exporter and forfaiter negotiate financing in which the forfaiter discounts the payments promised by the importer 3.The importer signs a sequence of promissory notes obliging it to pay the exporter certain sums, usually every 6-12 months, contingent on the exporter performing certain functions related to the project 4.The importer delivers the notes to the exporter and the exporter endorses the notes and sells them to the forfaiter 5.The forfaiter endorses the notes and sells them in the money market 6.The notes are presented to the importer or its bank at maturity

© 2012 Pearson Education, Inc. All rights reserved Financing Exports Export factoring – a company that performs credit risk investigations and collects funds from the A/R of other firms –Closely related to forfaiting –Gives two types of credit approvals: order approvals and revolving credit lines –Methods of payments Collection basis – exporter gets paid when factor receives funds from the importer (actual or average) Maturity basis – payment is based on weighted average maturity date of all invoices maturing in a particular month Through a bank Tripartite arrangement – factor services the exporter, which assigns any credit balances due from the factor to a financial intermediary

© 2012 Pearson Education, Inc. All rights reserved Financing Exports Government sources of export financing and credit insurance –Specialized financial intermediaries, a.k.a. export credit agencies (ECA) Ex-Im Bank – United States Private Export Funding Corporation (PEFCO) Export credit insurance (e.g., SINOSURE in China)

© 2012 Pearson Education, Inc. All rights reserved Countertrade Countertrade allows exporters and importers to exchange goods and services without having to use money as a medium of exchange –UN estimates that at least 25% of international trade involves some form of countertrade –Global Offset and Countertrade Association (GOCA) has semi-annual conferences and a website on practice

© 2012 Pearson Education, Inc. All rights reserved Exhibit 18.7 Types of Countertrade