Financing Foreign Trade

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Financing Foreign Trade

• International Financial Management

Dr. A. DeMaskey
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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?

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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.

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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

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Documentations in Import/Export Transactions

• 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

• 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.

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International Trade Risks
The Trade Transaction Timeline
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Documentation of Foreign Trade Transactions

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

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

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Letter of Credit (L/C)

• A letter of credit is a banks 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
• Banks L/C must contain specified maturity date
• Banks commitment must have stated maximum amount
• Banks obligation must arise only on presentation
  of specific documents and bank cannot be called
  on for disputed items
• Banks customer must have unqualified obligation
  to reimburse bank on same condition of banks
  payment

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Letter of Credit (L/C)

• Commercial L/Cs 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

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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
The relationship between the importer and the
exporter is governed by the sales contract
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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
• Buyers bank is drawee of draft

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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

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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 bankers acceptance.
• When drawn on a business firm it becomes a trade
  acceptance.

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Bankers Acceptance

• When a draft is accepted by a bank, it becomes a
  bankers 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.

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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

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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.

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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.

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Government Programs for Export Financing

• Export Credit Insurance
• Provides assurance to the exporter or the
  exporters 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.