Financing Foreign Trade

International Financial Management

Learning Objectives

• What are the key elements of an import or export transaction?• What are the three key documents in import or export transactions?• What are some private sector export financing sources?• What are some public sector export financing sources?

International Trade Finance

• Trade financing shares a number of common characteristics with traditional value chain activities conducted by all firms.• All companies must search out suppliers for goods and services.• Must determine if supplier can provide products at required specifications and

quality.• All must be at an acceptable price and delivered in a timely manner.

Elements of an Import/Export Transaction•Every export sales transaction covers three basic

elements: • Contracts• contractual exchange between parties in two countries • description of goods

• Prices • price quotations and terms in the contract should conform to

published catalogues.• Documents • provides shipping and delivery instructions

Documentations in Import/Export Transactions

• Bills of lading (B/L) • issued to the exporter by a

common carrier transporting the merchandise

• Commercial invoice • issued by the exporter and contains

a precise description of the merchandise.

• 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

• Packing lists • may be required so that the

contents of containers can be identified

International Trade Risks

Price

Quote

request

Export

contract

signed

Goods

are

shipped

Documents

are

accepted

Goods

are

received

Cash

settlement

of the

transaction

Negotiation Backlog

Documents are

presented

Financing Period

Time and Events

The Trade Transaction Timeline

Documentation of Foreign Trade Transactions

•Key Documents• Letter of Credit• Bill of Lading• Draft

•Function• Risk of noncompletion• Foreign exchange rate risk• Financing foreign trade

Letter of Credit (L/C)

• A letter of credit 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 a L/C is the promise of the issuing bank to

pay against specific documents.• 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 and bank cannot be called on for disputed items• Bank’s customer must have unqualified obligation to reimburse

bank on same condition of bank’s payment

Letter of Credit (L/C)

•Commercial L/C’s are classified as:• Irrevocable vs. Revocable –• irrevocable letters of credit are non-cancelable while its opposite

can be cancelled at any time• Confirmed vs. Unconfirmed • issued by one bank and confirmed by another bank

•Advantages of L/Cs: • it reduces risk of default• a confirmed L/C helps secure financing

•Disadvantages of L/Cs: • the fees charged • reduces the available credit of the importer

Relationships Among the Three Parties to a Letter of Credit

The relationship between the issuing bank and the exporter is governed by the terms of the letter of credit, issued by that bank

The relationship between the importer and the issuing bank is governed by the terms of the application and agreement for the letter of credit

Beneficiary (exporter)

Applicant (importer)

Issuing Bank

The relationship between the importer and the exporter is governed by the sales contract

Bill of Exchange

•A draft, or bill of exchange (B/E), 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.• Trade draft• Buyer is drawee of draft

• Bank draft• Buyer’s bank is drawee of draft

Negotiable Instruments

• If properly drawn, drafts can become negotiable instruments.• As such they provide a convenient instrument for financing

the international movement of merchandise.• To become a negotiable instrument, there are four

requirements:• Must be written and signed by buyer• Must contain unconditional promise to pay • Must be payable on demand or at a fixed date• Must be payable to bearer

Types of Drafts

• Sight drafts • which is payable on presentation to the drawee.

• Time drafts• which allows a delay in payment. • it is presented to the drawee who accepts it with a promise to pay at some

later date.• When a time draft is drawn on a bank, it becomes a banker’s acceptance.• When drawn on a business firm it becomes a trade 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

Less 1.5% p.a. commission for 6 months

Amount received by exporter in 6 months

Less 7% p.a. discount rate for 6 months

Amount received by exporter at once

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

Characteristics of the Bill of Lading•A straight B/L • provides that the carrier deliver the merchandise to the

designated consignee only.•An order B/L • directs the carrier to deliver the goods to the order of a

designated party, usually the shipper.•A B/L is usually made payable to the order of the

exporter.

Additional Financing Techniques Used in International Trade•Discounting• Converting a trade draft into cash.

•Factoring• Selling export receivables at a discount to a factor.• Expensive but may be of great value to the occasional

exporter.•Forfaiting• Discounting at a fixed rate without recourse of medium-

term export receivables denominated in fully convertible currencies.

Government Programs for Export Financing•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.