Export & Import Financing

Export & Import Financing Chapter Twenty Eiteman, Stonehill, & Moffett Chapter 20 - Trade financing

Trade payment terms • cash in advance • draft • bill of exchange • letter of credit (L/C) • bankers acceptance • consignment • open account Chapter 20 - Trade financing

Cash in advance • Advantages • least risky alternative • risk is shifted entirely to the importer • Disadvantages • may be non-competitive, lose business • preferred if goods made to order • for purpose of financing the production Chapter 20 - Trade financing

Draft - bill of exchange • issued and signed by the exporter (drawer) • unconditional orders to pay (for the importer) • on demand (sight draft) • at a specified time in the future (time draft) • fixes the amount of manner of payment • time draft becomes an acceptance • when accepted by drawee (exporter) • L/C (promise of banker’s acceptance) • draft (bill of exchange) accepted by bank Chapter 20 - Trade financing

Draft - types of drafts • documentary drafts • drafts which require supporting documentation • bills of lading, invoices, etc. • drafts accompanying trades are documentary • non documentary (clean) • non-commercial transactions Chapter 20 - Trade financing

Drafts - mechanics • a draft extends credit • receivable to the exporter • payable to the importer • exporter gives control of goods to importer • for the signature on draft • contract between exporter and importer only • transferable (usually banker’s acceptances) • at discount to bank, acceptance dealer • rate lower than prime Chapter 20 - Trade financing

L/C - terms • promise of payment issued by the importer’s bank • binds the importer’s bank to pay determining • currency of payment • timing of payment • amount of payment • binds the exporter to deliver a certain product • quantity of goods • quality of goods • delivery date for goods Chapter 20 - Trade financing

L/C - advantages exporter • reduces credit risk • the bank’s reputation is on line • reduces political risk • banking system is tied into the political system • reduces pre-shipment risk • contracted terms for delivery of goods Chapter 20 - Trade financing

L/C - advantages importer • reduces delivery risk • contract stipulates delivery terms • bank oversees custom’s procedures • importer can contract for better terms • exporter’s risk substantially reduced • prepayment by importer goes to bank • if the shipment is not satisfactory easier for importer to recover payment Chapter 20 - Trade financing

L/C - types of L/Cs • documentary L/Cs • L/Cs which require supporting documentation • bills of lading, invoices, etc. • majority of L/Cs are documentary • non documentary (clean) • non-commercial transactions • irrevocable L/C • cannot be revoked except by mutual consent • revocable (rarely used) better than nothing Chapter 20 - Trade financing

L/C - types of L/Cs con’t • confirmed L/C by an other bank • usually a bank in the exporter’s country • obligates both banks to honor the obligation • unconfirmed L/C- obligates issuing bank • transferable L/C • right to transfer, must be contracted • transfer of L/C and supporting documents • assignment • assigning part of the proceeds to another party Chapter 20 - Trade financing

Banker’s acceptance • acceptance of the draft by a bank • bank substitutes its credit for importer’s credit • if transferable - creates a negotiable instrument • may discount this to the exporter • resell in secondary markets • terms • maturities 30, 60, 90 days • bank profits from • fee on L/O, discount on acceptance Chapter 20 - Trade financing

Banker’s acceptance - hold • PV of 1,000,000 usd • less 2% annual commission • less 9.7% wacc • exporter gets BA and holds to term • exporter hedges transaction exposure Chapter 20 - Trade financing

Banker’s acceptance - discount • PV of 1,000,000 usd • less 2% commission per annum • less 10.4% discount per annum • exporter gets BA and discounts • exporter gets into exchange market now Chapter 20 - Trade financing

Mechanics of a trade • few weeks after contract • goods, price, quantity, quality • production of goods financed by • increase in input inventories, by payables • labor inputs by accruals • result an increase in output inventories • payables, accruals must be paid • payment financed by short-term financing Chapter 20 - Trade financing

Mechanics of a trade - con’t • goods shipped • output inventories still carried as assets • goods, bill of lading, draft sent • L/C sent to exporter • delivery of goods • goods, bill of lading, draft at customs • time draft accepted • by importer (acceptance) • by importer’s bank (bankers acceptance) • output inventories now change to receivables Chapter 20 - Trade financing

Mechanics of a trade con’t • Banker’s acceptance may be transferable • can be held by exporter for payment • receivable stays on exporters books • payable stays on importers books • must hedge transaction exposure if it exists • Banker’s acceptance if transferable • can be discounted • sold at discount to a bank or broker • then receivable becomes cash • payable still on importers books Chapter 20 - Trade financing

Mechanics of a trade con’t • Risk if BA discounted • foreign exchange exposure exists • from time contract agreed to • until draft is accepted by the importer’s bank • BA signed • credit risk • higher until draft accepted (BA signed) • lower until BA discounted Chapter 20 - Trade financing

Mechanics of a trade con’t • Risk if L/C held to maturity • foreign exchange exposure exists • from time contract agreed to • L/C matures • credit risk • higher until draft accepted (L/C issued) • lower until L/C matures Chapter 20 - Trade financing

Consignment • exporter retains title to good shipped • importer gains possession, but not title • very risky • easy for importer to default on this type of arrangement • terms • whatever the importer sells is paid for • goods not sold returned Chapter 20 - Trade financing

open account • most flexible • importer receives goods - a payable • acceptance by importer sufficient • reduces bank charges • risky - no bank guarantee on payment • importer and exporter need to have a good stable relationship Chapter 20 - Trade financing

Documents of trade • bill of lading B/L • contract between exporter and carrier • straight B/L - consigns good to importer • order B/L - transferable • often serves as collateral for L/C • on board B/L - on board being shipped • received-for-shipment B/L • received, but not shipped • clean B/L - goods(externally) look undamaged Chapter 20 - Trade financing

Other documents • commercial invoice • full description of merchandise • insurance • open (floating) prearrangement with insurer to cover shipments made • requires an insurance certificate which must conform to information on B/L • consular invoice Chapter 20 - Trade financing

Factoring • firms that buy a firm’s receivables at discount • non-recourse basis - factor assumes all risk • recourse - exporter assumes risk • factoring fees can run from 1.75 to 2 % per month • compounded from 23.14 to 26.82 % per year • on top of this non-recourse fees can add to this Chapter 20 - Trade financing

Export financing • export-import banks • finance exports of goods and services • subsidy to try to create new markets for exports • these are not market driven • very bureaucratic & often political • export-credit insurance • low cost credit insurance • lowers the cost of borrowing by reducing risk Chapter 20 - Trade financing

Countertrade • barter • direct exchange of goods between two parties • counter purchase - parallel barter • continued sale and purchase of goods • Finland frequently sold manufactured goods for raw materials (oil) with the former Soviet Union • buyback • repayment of exports made by the sale of related product Chapter 20 - Trade financing

Payment terms • evolving instruments of international trade • these instruments and methods are used to • facilitate trade by exploiting comparative advantage • reduce risk • who • how much • its cost Chapter 20 - Trade financing

Export & Import Financing