324_International Trade Finance

Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*International Trade Finance: Learning Objectives Learn how international trade alters both the supply chain and general value chain of the domestic firm, thereby beginning the globalization process in the trade phase

Consider what the key elements in an import or export transaction are in business

Discover how the three key documents in import-export the letter of credit, the draft, and the bill of lading combine to finance the transaction and to manage its risks

Copyright 2009 Pearson Prentice Hall. All rights reserved.

Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*International Trade Finance: Learning Objectives Identify what the documentation sequence is for a typical international trade transactionLearn how the various stages and their costs affect the ability of an exporter to enter a foreign market and potentially compete in both credit terms and pricingSee what organizations and resources are available for exporters to aid in managing trade risk and financingExamine the various trade financing alternatives


International BusinessInternational businessAll business activities that involve exchanges across national boundariesSome countries are better equipped than others to produce particular goods or servicesAbsolute advantageThe ability to produce a specific product more efficiently than any other nationComparative advantageThe ability to produce a specific product more efficiently than any other productGoods and services are produced more efficiently when each country specializes in the products for which it has a comparative advantage3 | *

Prentice Hall, 2005Business In Action 3eChapter 3 - *Why Nations Trade

Business In Action 3e

International Trade BenefitsCountrys total output increasesOffering lower prices Variety of products Allows companies to expand their markets and achieve production and distribution efficiencies


Top Ten Merchandise-Exporting StatesSource: http://www.ita.doc.gov/td/industry/otea/state/2005_year_end_dollar_value_05.html, accessed May 23, 2010.3 | *

Prentice Hall, 2005Business In Action 3eChapter 3 - *MeasuringInternational Trade

Business In Action 3e

U.S. International Trade inGoods and ServicesSource: U.S. Department of Commerce, International Trade Administration, U.S. Bureau of Economic Analysis, http://bea.gov/international/bp_web/simple.cfm?anon=90730&table_id=1&area_id=3, accessed April 19, 2010.3 | *

Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*The Trade RelationshipTrade financing shares a number of common characteristics with traditional value chain activities conducted by all firmsAll companies must search out suppliers for goods and servicesMust determine if supplier can provide products at required specifications and qualityAll must be at an acceptable price and delivered in a timely manner


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*The Trade RelationshipUnderstanding the nature of the relationship between the exporter and the importer is critical to understanding the methods for import-export financing utilized in industryThree categories of relationships:Unaffiliated unknown party (detailed sales contract)Unaffiliated known party (exporter has previously conducted business successfully)Affiliated party (foreign importer that is subsidiary business unit)


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*The Trade DilemmaInternational trade must work around a fundamental dilemma:Imagine an importer and an exporter who would like to do business with one anotherBecause of the distance between the two, it is not possible to simultaneously hand over goods and receive payments in personHow do participants in international trade mitigate the risks associated with conducting business with a stranger?


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Key DocumentsAs we will see in the following exhibits, letters of credit, order bills of lading and sight drafts are critical in conducting international tradeAn example of a letter of credit occurs when an importer obtains a banks promise to pay on its behalf, knowing the exporter will trust the bankWhen the exporter ships the merchandise to the importers country, title to the merchandise is given to the bank on a document called an order bill of ladingThe exporter asks the bank to pay for the goods using a sight draftThe bank, having paid for the goods, now passes title to the importer who eventually reimburses the bank


Difference between a letter of credit (L/C) and a draft.

A Letter of Credit (L/C) is a document issued by a bank promising to pay if certain documents are delivered to that bank A draft is an order sent to that bank written by a business firm ordering the bank to make payment. (A personal check is a simple form of a bank draft.)Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Letter of Credit (L/C)Letter of Credit (L/C) 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/CThe essence of an L/C is the promise of the issuing bank to pay against specified documents, which means that certain elements must be present for the bankIssuing bank must receive a fee for issuing L/CBanks L/C must contain specified maturity dateBanks commitment must have stated maximum amountBanks obligation must arise only on presentation of specific documents and bank cannot be called on for disputed itemsBanks customer must have unqualified obligation to reimburse bank on same condition of banks payment


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Letter of Credit (L/C)Commercial L/Cs are classified as followsIrrevocable Vs. Revocable irrevocable letters of credit are non-cancelable while its opposite can be cancelled at any timeConfirmed Vs. Unconfirmed An L/C issued by one bank can be confirmed by another bank

Advantages of L/Cs are that it reduces risk of default and a confirmed L/C helps secure financing

Disadvantages of L/Cs are the fees charged and that the L/C reduces the available credit of the importer


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*DraftA draft, sometimes called a bill of exchange (B/E) - check, is the instrument normally used in international commerce to effect paymentIt is a written order by an exporter instructing an importer or its agent to pay a specified amount at a specified timeThe party initiating the draft is the maker, drawer, or originator while the counterpart is the draweeIn a commercial transaction where the buyer is the drawee it is a trade draft, or the buyers bank when it is called a bank draft


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*DraftIf properly drawn, drafts can become negotiable instrumentsAs such they provide a convenient instrument for financing the international movement of merchandiseTo become a negotiable instrument, there are four requirementsMust be written and signed by buyerMust contain unconditional promise to pay Must be payable on demand or at a fixed dateMust be payable to bearer


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*DraftTypes of drafts includeSight drafts which is payable on presentation to the drawee (exporter is paid at once)Time drafts exporter receives the expected draft (bankers acceptance) back from the bank, allow a delay in payment. It is presented to the drawee who accepts it with a promise to pay at some later dateWhen a time draft is drawn on a bank, it becomes a bankers acceptance. Exporter may hold the bankers acceptance until maturityWhen drawn on a business firm it becomes a trade acceptance


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Bankers AcceptanceWhen a draft is accepted by a bank, it becomes a bankers acceptanceExample: Acceptance of $100,000 for exporter

Exporter may discount the acceptance note in order to receive the funds up-frontFace amount of acceptance$100,000Less 1.5% p.a. commission for 6 months- 750Amount received by exporter in 6 months$ 99,250Less 7% p.a. discount rate for 6 months- 3,500Amount received by exporter at once$95,750Bankers Acceptances


20-*Bill of LadingBill of Lading (B/L) is issued to the exporter by a common carrier (is a person or company that transports goods or people for any person or company and that is responsible for any possible loss of the goods during transport) transporting the merchandise: details a shipment of merchandise, gives title to the goods, and requires the carrier to deliver the merchandise to the appropriate partyIt serves the purpose of being a receipt, a contract and a document of titleAs a contract the B/L indicates the obligation of the carrier to provide certain transportationAs 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

Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Bill of LadingCharacteristics of the Bill of LadingA straight B/L provides that the carrier deliver the merchandise to the designated consignee ( ) onlyAn 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


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Documentation in TypicalTrade TransactionExample: Assume Trident receives order from Canadian buyer; Trident will export financed under L/C requiring a bill of lading with exporter collecting a time draft accepted by Canadian buyers bankThe Canadian buyer places order with TridentTrident agrees to ship under L/CCanadian buyer applies to bank (Northland Bank) for L/C to be issued in favor of Trident for merchandiseNorthland Bank issues L/C in favor of Trident and sends it to Southland Bank (Tridents bank)


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Documentation in TypicalTrade TransactionTrident ships the goods to the Canadian buyerTrident prepares a time draft and presents it to Southland Bank. The draft is drawn on Northland Bank with required documents including bill of ladingTrident endorses () the order bill of lading in blank so that title to goods goes with holder of documents Southland BankSouthland Bank presents draft and documents to Northland Bank for acceptance, Northland accepts and promises to pay draft at maturity 60 days


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Documentation in TypicalTrade TransactionNorthland Bank returns accepted draft to Southland Bank; Southland Bank could ask for discounted draft receiving funds todaySouthland Bank, now having a bankers acceptance, may sell the acceptance in the open market or it may hold the acceptance in its own portfolioIf Southland Bank had kept the acceptance, it would transfer the proceeds less commission to Trident


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Documentation in TypicalTrade TransactionNorthland Bank notifies Canadian buyer of arrival of documents; Canadian buyer signs note to pay Northern Bank for the merchandise in 60 daysAfter 60 days, Northland Bank receives payment from Canadian buyerOn same day, holder of matured acceptance presents it for payment and receives it face value; it may be presented at Northland Bank or returned to Southland Bank for collection through normal bank channels


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Government Programs to Help Finance ExportsGovernments of most export-oriented industrialized countries have special financial institutions that provide some form of subsidized credit to their own national exportersThese export finance institutions offer terms that are better than those generally available from the competitive private sectorThus, domestic taxpayers are subsidizing lower financial costs for foreign buyers in order to create employment and maintain a technological edge


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Government Programs to Help Finance ExportsExport Credit InsuranceProvides assurance to the exporter or the exporters bank that an insurer will pay should the foreign customer defaultIn the US the Foreign Credit Insurance Association (FCIA) provides this type of insuranceExport-Import BankKnown as the Eximbank, it facilitates the financing of US exports through various loan guarantee and insurance programs


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Trade Financing AlternativesIn order to finance international trade receivables, firms use the same financing instruments as they use for domestic trade receivables including;Bankers AcceptancesTrade AcceptancesFactoringSecuritizationBank Credit Lines Covered by Export Credit InsuranceCommercial Paper


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Forfaiting: Medium and Long Term FinancingForfaiting is a specialized technique to eliminate the risk of nonpayment by importers in instances where the importing firm and/or its government is perceived by the exporter to be too risky for open account creditThe essence of forfaiting is the non-recourse sale by an exporter of bank-guaranteed promissory notes, bills of exchange, or similar documents received from an importer in another countryThe following exhibit outlines a typical forfaiting transaction


International Trade AgreementsThe General Agreement on Tariffs and Trade and the World Trade OrganizationGeneral Agreement of Tariffs and Trade (GATT)International organization of 153 nations dedicated to reducing or eliminating tariffs and other trade barriersMost-favored-nation status (MFN)Each member of GATT was to be treated equally by all other membersKennedy Round, Tokyo Round, Uruguay Round, Doha Round

3 | *

WTO Members Share in World Merchandise TradeSource: www.wto.org, accessed on May 25, 2010.3 | *

The Evolving European UnionSource: http://europa.eu/abc/european_countries/index_en.htm, accessed May 25, 2010.3 | *

Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Summary of Learning ObjectivesInternational trade takes place between three categories of relationships: unaffiliated unknown parties, unaffiliated known parties, and affiliated partiesTrade transactions between affiliated parties typically do not require contractual arrangements or external financing. Trade transactions between unaffiliated parties typically do as well as some type of external financing such as letters of credit


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Summary of Learning ObjectivesOver many years, established procedures have arisen to finance international trade. The basic procedure rests on the interrelationship between three key documents, the L/C, the draft, and the bill of ladingVariations in each type of the three documents provide a variety of ways to accommodate any type of transactionIn the simplest transaction, in which all three documents are used, an importer applies for and receives a L/C from its bank


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Summary of Learning ObjectivesIn the L/C, the bank substitutes its credit for that of the importer and promises to pay if certain documents are submitted to the bank. The exporter may now rely on the promise of the bank rather than that of the importerThe exporter typically ships on an order bill of lading, attaches the bill of lading to a draft ordering payment from the importers bank and presents these documents, plus any additional documents, through its own bank to the importers bank


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Summary of Learning ObjectivesIf the documents are in order, the importers bank either pays the draft (sight draft) or accepts the draft (time draft). In the latter case, payment is at a future date. At this step the importers bank acquires title to the merchandise through the bill of lading and releases it to the importer against a promise to payIf a sight draft is used, the exporter is paid at once, if a time draft is used the exporter receives the accepted draft, now a bankers acceptance, back from the bank and holds it until maturity or sells it at a discount


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Summary of Learning ObjectivesTotal costs of an exporter entering a foreign market include the transaction costs of trade financing, import/export duties and the costs of foreign market penetration which includes distribution, inventory and transportation expensesExport credit insurance provides assurance to exporters that insurance will pay should importer defaultIn the US, the Foreign Credit Insurance Association provides this insuranceThe Ex-Im bank is an independent agency established to stimulate and facilitate the foreign trade of the US


Copyright 2009 Pearson Prentice Hall. All rights reserved.20-*Summary of Learning ObjectivesTrade financing uses the same financing instruments as in domestic receivables financing, plus some specialized instruments that are only available for financing international tradeA popular instrument for short-term financing is a bankers acceptance; its all-in-cost being comparable to other money market instruments such as marketable bank certificates of depositOther short-term financing instruments with a domestic counterpart are trade acceptancesForfaiting is an international trade technique that can provide medium and long-term financing


***International trade is rarely simple, but its a fact of life for all countries, for two reasons:No single country has the resources and capabilities to produce everything its citizens want or need. Businesses and countries specialize in the production of certain goods and engage in international trade to obtain raw materials and goods that are unavailable to them or too costly for them to produce. Many companies have ambitions that are too large for their own backyards. All this international activity involves more than just sales growth. By expanding their markets, companies can benefit from economies of scale when they purchase, manufacture, and distribute in higher quantities. In addition to helping companies, international trade helps consumers by giving them more options and lower prices, and it helps governments by generating more revenue. *Two key measurements of a nation's level of international trade are the balance of trade and the balance of payments.The total value of a country's exports minus the total value of its imports, over some period of time, determines its balance of trade. In years when the value of goods and services exported by the United States exceeds the value of goods and services it imports, the U.S. balance of trade is said to be positive: People in other countries buy more goods and services from the United States than the United States buys from them, creating a trade surplus. Conversely, when the people of the United States buy more from foreign countries than the foreign countries buy from the United States, the U.S. balance of trade is said to be negative. That is, imports exceed exports, creating a trade deficit. The balance of payments is the broadest indicator of international trade. It is the total flow of money into the country minus the total flow of money out of the country over some period of time. The balance of payments includes the balance of trade plus the net dollars received and spent on foreign investment, military expenditures, tourism, foreign aid, and other international transactions.

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