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Important Terms
Beneficiary : the recipients of funds or other benefits (exporter) Irrevocable : Incapable of being retracted or revoked Time Draft : a written order instructing the importer or the importer bank to pay the amount specified on its face on a certain date. A bill of lading : a document issued by the common carrier specifying that it has received the goods for shipment, it can serve as title to the goods. Banker Acceptance (B/A) : a negotiable money market instrument for which a secondary market exists.
1. International Trade
The trade/exchange of capital, goods, and services across international borders or territories.*
*Sources : http://en.wikipedia.org/wiki/International_trade
2. Methods of Payment
Open Account Documentary Collection Letters of Credit Cash-inAdvance
Least Secure
Exporter
Importer
Most Secure
Cash-inAdvance
Letters of Credit
Documentary Collection
Open Account
Payment Method should be chosen carefully to minimize the payment risk, while also accomodating the buyers need.
For exporter, any sales is a GIFT until payment is received (they want to receive payment as soon as possible, as an order is places before the goods are sent to the importer) For importer any payment is DONATION until the goods are received (they want to received the goods as soon as possible and delay payment as long as possible, preferably until the goods are the resold and generate enough income to pay the exporter)
2a. Cash-in-Advance
Payment in advance trough credit card / banks check / wiretransfer before the ownership of the goods is transferred. Applicable for high-risk trade relationships and ideal for internet-based businesses.
Advantages : 1. Payment before shipment 2. Eliminates risk of non-payment 3. No risk for exporter
Disadvantages : 1. May lose customer to competitors over payments terms 2. No additional earnings trough financing operation 3. High risk for importer
Disadvantages : 1. Complex and laborintensive process 2. Relatively expensive method in terms of transaction costs
Risk evenly spread between seller and buyer, provided that all terms and conditions are adhered to.
Fact about LC
LC is a separate contract from the sales contract. (the bank is not concerned whether each party fulfill the terms in sales contract or not). The bank obligation to pay is solely conditioned upon the sellers compliance with the terms and conditions of the LC (bank only deal in document, not goods). LC can be arranged easily for one-time deals LC is always irrevocable (may not be changed or cancelled unless the seller agrees)
5
B/A 12
Shipment of goods
10 11 14
13
16
3
Importers Bank
Letter of Credit
Shipping Documents and
Exporters Bank
Importer (USA)
5
11
Exporter (China)
4 9
14
10
2 7
Importers Banks
15 13
Exporters Banks 8
5. The chinese exporter will ship the machine to USA. 6. After shipping the sewing machine, Chinese exporter will present to their bank a (60-day) time draft, a bill of lading, invoice and packing list. 7. The China bank presents the shipping documents and the time drafts to the USA bank. The USA bank accept the time draft and make a bankers acceptance and charges an acceptance commission which is deducted at the time of final settlement. This commission is based on the term-to-maturity of the time draft and creditworthiness of the importer. 8. Chinese exporter has a choice to hold the B/A until the maturity date or sell it at a discount price. Since the risk is similar and B/A trade rate is similar to the deposit rate of other bank. Suppose Chinese exporter instruct their bank to have the B/A discounted by the USA bank.
9. USA bank pay that amount of discounted B/A. 10. USA importer signs a (60-day) promissory note with USA bank for the face value of the B/A, due on the maturity date. 11. China Bank provides the auto-dealer with the shipping documents needed to take possesion of the sewing machines. 12. If B/A is no t held by Chinese exporter or China Bank, USA bank may hold it until maturity date and collect face value from the USA importer via promissory note. So USA bank may sell the B/A in the money market to investor. 13. An investor will buy it at a discount price from face value. 14. USA bank will collect the face value of the B/A via the promissory note 15. The money market investor will present the B/A for payment to USA bank 16. USA bank will pay the face value of B/A to the investor.
Formula
Maturity Value : = Face Value x [1-(commission x days/360) Discounted Value : = Face Value x [1-{(B/A rate + Commission Rate) x days/360}] Commission Accepted : = Face Value Maturity Value Bond equivalent yield : = {(maturity value/discounted value)-1} x (365/days)
But if chinese exporter wants to discount the B/A with USA bank, they will receive : = $ 1,000,000 x [1-{(0.525 + 0.0150) x (60/360)}] = $ 988,750 Regardless the chinese exporter want to hold the B/A to maturity or not, they have to pay the bank commission. The importer bank commission is : Face Value Maturity Value : = $1,000,000 - $997,500 = $ 2,500
The bond equivalent yield at maturity date is : = {($ 1,000,000/$ 988,750-1) x 365/60} = 0,0692 = 6,92% ( note : 365 is the actual number of days in the year, instead of bankers day) The bond equivalent rate the exporter received from discounting B/A is = {(($997,500/$998,750)-1)x365/60} = 0,0538 = 5,38% If the opportunity cost of capital is greater than 5,38%, discounting makes sense, if not, Chinese exporter should hold it until maturity.
Explanation :
Exporter sends goods to custom and presents the document with instruction for obtaining payment to the exporter bank. Importer give the document of purchasing Exporter tell the remitting bank to send the document to the collecting bank. The remitting bank sends the document to the collecting bank Collecting bank releases the document to the importer, receipt of payment or a acceptance of the drafts. This documents uses to obtain the goods & to clear them at the customs. Importer pay the money to the collecting bank (debited account) After receives the payment, collecting bank forward the proceeds to the remitting bank The remitting bank then credits the exporters account.
By using several techniques : a. Export working capital financing b. Government-guaranteed export working capital programs c. Export credit insurance d. Export factoring
Advantages : Encourages lenders to offer financing to exporters Enables lenders to offer generous advance rates
Disadvantages : Cost of obtaining and maintaining a guaranteed facility Additional costs associated with risk mitigation measures
d. Export Factoring
Complete financial package that combines EWC financing, credit protection, foreign accounts receivable bookkeeping and collection services. This bank or special financial firm offered under an agreement between the factor and exporter in which the factor purchases the exporter s short term foreign accounts receivable for cash at a discount from the face value, without recourse. Advantages : Eliminating risk of non-payment by foreign buyers Handles collections on the receivables, Improves liquidity position and cash flow. Disadvantages : More costly than export credit insurance Generally not available in developing countries
Countertrade
Countertrade consists of transactions which have as a basic characteristic a linkage, legal or otherwise, between exports and imports of goods or services in addition to, or in place of, financial settlements. Countertrade can be used as an effective international business tool. Countertrade plays a part in 20-25 percent of world trade that carried out wholly or partially in goods rather than money.
Sources : http://www.witiger.com/internationalbusiness/countertrade.htm
Why Countertrade ?
1. The world debt crisis has made ordinary trade financing very risky. (Large banks and financial institutions are "risk adverse" in many of the hostile regions of the world opening to trade). 2. Many countries cannot obtain the trade credit or financial assistance to pay for desired imports. (The IMF and World Bank are increasingly restrictive in the way they allow governments to operate). 3. Countries are increasingly returning to the notion of bilateralism as a way to reduce trade imbalances. 4. Countertrade is often viewed as an excellent mechanism to gain entry into new markets. The party receiving the goods may become a new distributor, opening up new international marketing channels and ultimately expanding the market. 5. Providing countertrade services helps sellers differentiate its products from those of competitors. (Flexibility is key to winning business in a global market that is more and more competitive to vendors)
Forms of Countertrade
Barter- direct exchange of goods or services having equivalent values without a cash transaction Counterpurchase: involves 2 simultaneous separate transactions between 2 parties with or without cash Buyback or compensation: involves repayment in the form of goods derived from directly from, or produced by, the technology, plant, or equipment provided by the seller Offsets: involves an arrangement whereby the seller is required to assist in or to arrange for the marketing of products produced by the buying country or to allow some portion of the exported product to be assembled or manufactured by producers located in the buying country. Switch-trading: refers to a switch in the country of destination goods
Countertrade conserves cash and It is inefficient. hard currency. Some claim that such The improvement of trade transactions tamper with the imbalances, the maintenance of fundamental operation of free export prices, enhanced economic markets, and therefore development, increased resources will be used employment, technology transfer, inefficiently. market expansion, increased profitability, less costly sourcing of Transactions that do not make use of money represent a huge supply reduction of surplus goods step backwards in economic from inventory, and the development. development of marketing expertise.
Forfaiting
A method of trade financing that allows exporter to obtain cash by selling their medium-term foreign accounts receivable at a discount on a without recourse basis.
A forfaiter is a specialized finance firm or a department in a bank that performs non-recourse export financing trough the purchase of medium term trade receivables. It eliminates the risk of non-payment once the goods have been delivered to the foreign buyer in accordance with the terms of sale.
Applicable for exports of capital goods, commodities, and large projects on medium term credit (180 days to 7 years) Risk inherent in an export sale is virtually eliminated. Receivables are normally guaranteed by the importers bank which allows the exporter to take the transaction off the balance sheet to enhance financial ratios. The current minimum transaction size for forfaiting is $ 100,000 Advantages : Eliminates the risk of nonpayment by foreign buyers. Offers strong capabilities in emerging and developing markets. Disadvantages : Cost is often higher than commercial lender financing Limited to medium-term transactions and those exceeding $100.000
Cost of Forfaiting : the cost is determined by the rate of discount based on the aggregate of the LIBOR (London Inter Bank Offered Rate) for the tenor of the receivables and a margin reflecting the risk being sold. The degree of risk varies based on the importing country, the length of loan, the currency of transaction and the repayment structure. (the higher the risk, the higher the margin and the higher the discount rate)
Three additional major advantages of forfaiting : a. Volume : forfaiting can work on a one-shot deal, without requiring an ongoing volume of business b. Speed : commitments can be issued within hours or days depending on details and country c. Simplicity : documentation is usually simpel, concise and straightforward.
Benefits of Forfaiting
Eliminates Risk * Removes political, transfer and commercial risk * Provides financing for 100% of contract value * Protects against risks of interest rate increase and exchange rate fluctuation Enhances Competitive Advantage * Enables sellers of goods to offer credit to their customers, making their products more attractive * Helps sellers to do business in countries where the risk of non-payment would otherwise be too high
Problem 1 :
1. Assume the time from acceptance to maturity on a $ 2,000,000 bankers acceptance is 90 days. Further assume that the importing banks acceptance commission is 1.25 percent and that the market rate for 90-day B/A is 7 percent. Determine the amount the exporter will receive if he holds the B/A until maturity and also the amount the exporter will receive if he discounts the B/A with the importers bank.
Problem 2 :
2. The time from acceptance to maturity on a $1,000,000 bankers acceptance is 120 days. The importers bank acceptance commission is 1.75 percent and the market rate for 120-days B/A is 5.75 percent. What amount will the exporter receive if he holds the B/A until maturity? If he discount the B/A with the importers bank? Also determine the bond equivalent yield the importer bank will earn from discounting the B/A with the exporter. If the exporters opportunity cost of capital is 11 percent, should he discount the B/a or hold it to maturity?
Conclusion
Conducting international trade transactions and trade financing is difficult in comparison to domestic trades. Commercial and political risk enter into the equation so it is Important for a country to be competitively strong in international trade. A typical foreign trade transaction requires three basic documents: letter of credit, time draft, and bill of lading. Forfaiting in which a bank purchase at a discount from an importer a series of promissory notes in favor of an exporter is a medium-term form of trade financing The export-import bank provide competitive assistance to exporters through direct loans to foreign importers, loan guarantees and credit insurance to the exporters. Countertrade transaction are gaining renewed prominence as a means of conducting international trade transactions.
Indonesia Importer