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INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICK

Fourth Edition

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 20-2

INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICK

Fourth Edition

Chapter Objective:

This chapter discusses the microstructure of international trade.

20Chapter Twenty

International Trade Finance

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Chapter Outline

A Typical Foreign Exchange Transaction Forfaiting Government Assistance in Exporting

The Export-Import Bank and Affiliated Organizations Countertrade

Forms of Countertrade Generalizations about Countertrade

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A Typical Foreign Exchange Transaction

Over the years, (centuries, really) an elaborate process has evolved for handling exports and imports.

Figure 20.1 illustrates this process

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Process of a Typical Foreign Trade Transaction

Importer’s Bank Exporter’s Bank

Importer Exporter

Money Market Investor

Purchase order1

L/ C

app

l ica

t ion

2Letter of Credit3

L/ C

not

i fi c

ati o

n

4

Shi

ppin

g do

cum

ents

an

d t i

me

draf

t

6

Pay

men

t di

s cou

nted

va l

ue

of B

/ A

9

5 Shipment of goods

Pa y

men

t fa c

e B

/A

14

Sig

ned

prom

iss o

ry n

ote

f or

f ac e

val

ue o

f B

/A

10

Shi

ppi n

g do

cum

ent s

11

Shipping Documents and

time draft accepted7

Payment-discounted value of B/A8

B/A

12

PV B/A

13 Face V

alue

B/A16B/A presented at maturity

15

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Letter of Credit

A guarantee from the importer’s bank that it will act on behalf of the importer and pay the exporter for the merchandise if all relevant documents specified in the letter of credit are presented according to the terms of the letter of credit. In essence the importer’s bank is substituting its

creditworthiness for that of the importer.

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Time Draft

A written order instructing the importer or his agent, the importer’s bank, to pay the amount specified on its face on a certain date.

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Bill of Lading

A document issued by the common carrier specifying that it has received the goods for shipment; it can serve as title for the goods.

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Banker’s Acceptances

The exporter’s bank presents the shipping documents and the time draft to the importer’s bank.

After taking title to the goods via the bill of lading, the importer’s bank accepts the time draft.

At this point the banker’s acceptance is created. It is a negotiable money market instrument. A secondary market exists for banker’s acceptances.

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Banker’s Acceptances

Banker’s acceptances can be held to maturity by the exporter.

The exporter can also sell it (at a discount) in the money market.

Since the risks are similar, B/As trade at rates comparable to certificates of deposit.

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Forfaiting

Forfaiting is a type of medium-term financing used to finance the sale of capital goods.

It involves the sale of promissory notes signed by the importer in favor of the exporter.

The forfait, usually a bank, buys the notes at a discount from face value from the exporter.

The exporter gets paid and does not have to carry the financing.

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Government Assistance in Exporting

For political reasons (having to do with mercantilism), most developed countries offer competitive assistance to domestic exporters.

This assistance often takes the form of subsidized credit that can be extended to exporters.

Also credit insurance programs that guarantee financing extended by private financial institutions are common.

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The Export-Import Bank and Affiliated Organizations

In 1934 the Eximbank of the United States was founded as an independent government agency to facilitate and finance U.S. export trade.

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The Export-Import Bank and Affiliated Organizations

Eximbank’s purpose is to provide financing in situations where private financial institutions are unable or unwilling to because:

1. The loan maturity is too long.

2. The amount of the loan is too large.

3. The loan risk is too great.

4. The importing firm has difficulty in obtaining hard currency.

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Countertrade

Countertrade is an umbrella term used to describe many different types of transactions each in “which the seller provides a buyer with goods or services and promises in return to purchase goods or services from the buyer”.

Countertrade may or may not involve the use of currency, as in barter.

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Forms of Countertrade

Barter The direct exchange of goods between traders. Barter

requires a double coincidence of wants. A clearinghouse arrangement is a form of barter in

which the traders agree to buy a certain amount of goods from each other. They set up accounts with each other that are debited

and credited as needed. At the maturity of the arrangement, the parties settle up in cash or merchandise.

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Forms of Countertrade

A switch trade is the purchase by a third party of one country’s clearing agreement balance for hard currency.

A buy-back transaction involves a technology transfer via the sale of a manufacturing plant. The seller of the plant agrees to buy back some of the

output of the plant once it is constructed.

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Forms of Countertrade

A counterpurchase trade agreement is similar to a buy-back transaction, but differs in that The output that the seller of the plant agrees to buy is

unrelated to the plant. An offset transaction can be viewed as a

counterpurchase trade agreement involving the aerospace/defense industry.

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Disadvantages of Countertrade

It is inefficient. Some claim that such transactions tamper with the

fundamental operation of free markets, and therefore resources will be used inefficiently.

Transactions that do not make use of money represent a huge step backwards in economic development.

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Advantages of Countertrade

Countertrade conserves cash and hard currency. Advantages also include the improvement of trade

imbalances, the maintenance of export prices, enhanced economic development, increased employment, technology transfer, market expansion, increased profitability, less costly sourcing of supply reduction of surplus goods from inventory, and the development of marketing expertise.

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Generalizations about Countertrade

There are advantages and disadvantages associated with countertrade.

It can benefit both parties and in some circumstances is the only trade possible.

Whether countertrade transactions are good or bad for the global economy, it appears certain that they will increase in the near future as world trade increases.

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End Chapter Twenty