FINC3240FINC3240International FinanceInternational Finance

Chapter 19Chapter 19

Financing International TradeFinancing International Trade

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ObjectivesObjectives

This chapter will:This chapter will:A. Describe methods of payment for A. Describe methods of payment for

international tradeinternational tradeB. Explain common trade finance B. Explain common trade finance

methodsmethodsC. Describe the major agencies that C. Describe the major agencies that

facilitate international trade with facilitate international trade with export export insurance and/or loan insurance and/or loan programsprograms

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Payment MethodsPayment Methods

1. Prepayment1. Prepaymenta.a. Same as cash in advanceSame as cash in advance

b.b. Payment usually by wire transferPayment usually by wire transfer

c.c. Method offers exporter (seller) greatest Method offers exporter (seller) greatest degree of protectiondegree of protection

d.d. Usually requested whenUsually requested when

1.1. First time buyerFirst time buyer

2.2. Danger of pre shipment cancellationDanger of pre shipment cancellation

3.3. Importer country has high political riskImporter country has high political risk

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Payment MethodsPayment Methods

2. Letters of Credit ( L/C )2. Letters of Credit ( L/C )a. an instrument issued by a bank on behalf of a. an instrument issued by a bank on behalf of the importer (buyer)the importer (buyer)

b.b. promising to pay the exporter upon promising to pay the exporter upon presentation of shipping documents in presentation of shipping documents in compliance with the terms stipulated therein. compliance with the terms stipulated therein.

c.c. In effect, the bank is substituting its credit In effect, the bank is substituting its credit for that of the buyer.for that of the buyer.

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Exhibit 19.2 Example of an Irrevocable Letter of Exhibit 19.2 Example of an Irrevocable Letter of CreditCredit

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Exhibit 19.3 Documentary Credit ProcedureExhibit 19.3 Documentary Credit Procedure

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Payment MethodsPayment Methods

3. Drafts (or bill of exchange) 3. Drafts (or bill of exchange) a. an unconditional promise drawn by the exporter that a. an unconditional promise drawn by the exporter that instructs the buyer to pay the face amount of the draft instructs the buyer to pay the face amount of the draft upon presentation of shipping documentsupon presentation of shipping documents

b.b. affords the exporter less protection than an L/C affords the exporter less protection than an L/C because the banks are not obligated to honor payments because the banks are not obligated to honor payments on on the buyer’s behalf.the buyer’s behalf.

c.c. sight draft---the buyer’s bank will not release the sight draft---the buyer’s bank will not release the shipping documents to the buyer until the buyer pays shipping documents to the buyer until the buyer pays the draft. (documents against payment)the draft. (documents against payment)

d.d. time draft---the buyer’s bank release the shipping time draft---the buyer’s bank release the shipping documents against signing of the draft. (documents documents against signing of the draft. (documents against acceptance)against acceptance)

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Payment MethodsPayment Methods

4. Consignment4. Consignmenta. exporter ships the goods to the importera. exporter ships the goods to the importer

while still retaining actual title to the while still retaining actual title to the merchandise. merchandise. b.b. The importer has access to the inventory The importer has access to the inventory but but does not have to pay for the goods until does not have to pay for the goods until they they have been sold to a third party. have been sold to a third party. c.c. The exporter is trusting the importer to The exporter is trusting the importer to remit remit payment for the goods sold at that time. payment for the goods sold at that time. d.d. If the importer fails to pay, the exporter has If the importer fails to pay, the exporter has

limited recourse because no draft is limited recourse because no draft is involved involved and the goods have already been sold.and the goods have already been sold.

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Payment MethodsPayment Methods

5. Open Account5. Open Accounta. The opposite of prepayment - the exporter a. The opposite of prepayment - the exporter ships the merchandise and expects the buyer ships the merchandise and expects the buyer to to remit payment according to theremit payment according to the

agreed-upon terms. agreed-upon terms.

b. The exporter is relying fully upon the financial b. The exporter is relying fully upon the financial creditworthiness, integrity, and reputation creditworthiness, integrity, and reputation

of of the buyer. the buyer.

c.c. method is used when the seller and buyer method is used when the seller and buyer have mutual trust and a great deal of have mutual trust and a great deal of

experience with each other.experience with each other.99

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Exhibit 19.1 Comparison of Payment MethodsExhibit 19.1 Comparison of Payment Methods

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Trade Finance MethodsTrade Finance Methods

1. Accounts Receivable Financing1. Accounts Receivable Financinga. could take the form of an open account a. could take the form of an open account shipment or a time draftshipment or a time draft

b. the bank will provide a loan to the exporter b. the bank will provide a loan to the exporter secured by an assignment of the account secured by an assignment of the account receivable.receivable.

c. If the buyer fails to pay, who will be c. If the buyer fails to pay, who will be responsible for repaying the loan?responsible for repaying the loan?

2. Factoring Receivables2. Factoring Receivablesthe exporter sells the accounts receivable the exporter sells the accounts receivable without recourse.without recourse.

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B. Trade Finance MethodsB. Trade Finance Methods

3. Letters of Credit ( L/C )3. Letters of Credit ( L/C )

4. Others4. Others

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Agencies That Motivate Agencies That Motivate International TradeInternational Trade

1. Export-Import Bank of the United 1. Export-Import Bank of the United StatesStatesa. Established in 1934 with the original goal of a. Established in 1934 with the original goal of

facilitating Soviet-American trade. facilitating Soviet-American trade. b. Its mission today is to finance and facilitate the b. Its mission today is to finance and facilitate the

export export of American goods and servicesof American goods and servicesc. maintain the competitiveness of American c. maintain the competitiveness of American

companies companies in overseas markets.in overseas markets.d. programs that are classified asd. programs that are classified as

1.) guarantees1.) guarantees2.) loans2.) loans3.) bank insurance3.) bank insurance4.) export credit insurance.4.) export credit insurance.

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Agencies That Motivate Agencies That Motivate International TradeInternational Trade

2. Private Export Funding Co. (PEFCO)2. Private Export Funding Co. (PEFCO)a. is owned by a consortium of commercial a. is owned by a consortium of commercial

banks and industrial companies.banks and industrial companies.b. provides medium and long-term fixed rate b. provides medium and long-term fixed rate financing to foreign buyers.financing to foreign buyers.

3. Overseas Private Investment Corporation (OPIC)3. Overseas Private Investment Corporation (OPIC)a self-sustaining federal agency responsible for a self-sustaining federal agency responsible for

insuring direct U.S. investments in foreign countries insuring direct U.S. investments in foreign countries against the risks of currency inconvertibility, against the risks of currency inconvertibility, expropriation, and other political risks.expropriation, and other political risks.

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ExampleExample

The Sports Exports Company produces footballs and exports them to a distributor in the United Kingdom. It typically sends footballs in bulk and then receives payment after the distributor receives the shipment. The business relationship with the distributor is based on trust. Although the relationship has worked thus far, Jim Logan (owner of the Sports Exports Company) is concerned about the possibility that the distributor will not make its payment.

Q1: what kind of method of payment could Jim use to ensure that he will be paid for the products he exports?

Answer: L/C

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Example (continue)Example (continue)Q2: Jim has discussed the possibility of expanding his export

business through a second sporting goods distributor in the United Kingdom; this second distributor would cover a different territory than the first distributor. The second distributor is only willing to engage in a consignment arrangement when selling footballs to retail stores. Explain the risk to Jim beyond the typical types of risk he incurs when dealing with the first distributor. Should Jim pursue this type of business?

Answer: With a consignment arrangement, the Sports Exports Company would retain title to the merchandise. Thus, it would not receive payment until after the second distributor sold the footballs. Also, even if the second distributor does sell the footballs but fails to pay for them, the Sports Exports Company has limited recourse.

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