international financial management 7

7/31/2019 International Financial Management 7

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Chapter 7*Financing International Trade


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Objectives

Th i s chap te r f i r s t sugges ts why

international trade can be difficult. Then,

it explains the various ways in whichbanking institutions can facilitate

international trade by resolving problems

faced by the exporter and importer.The specific objectives are:


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Objectives

to describe the methods of payment for

international trade;

to explain common trade finance methods;and

to describe the major U.S. agencies that

facilitate international trade with exportinsurance and/or loan programs.*


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Payment Methodsfor International Trade

In any international trade transaction, credit isprovided by either

the supplier (exporter),

the buyer (importer), one or more financial institutions, or

any combination of the above.

The form of credit whereby the supplier fundsthe entire trade cycle is known as supplier

credit.


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Method : Prepayments

The goods will not be shipped until thebuyer has paid the seller.

Time of payment: Before shipment

Goods available to buyers: After payment

Risk to exporter: None

Risk to importer: Relies completely onexporter to ship goods as ordered


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Method : Letters of credit (L/C)

These are issued by a bank on behalf of theimporter promising to pay the exporter upon

presentation of the shipping documents. Time of payment: When shipment is made


Risk to exporter: Very little or none

Risk to importer: Relies on exporter to ship

goods as described in documents


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Method : Drafts (Bills of Exchange)

* Sight drafts (documents against payment):When the shipment has been made, the draft is

presented to the buyer for payment. Time of payment: On presentation of draft


Risk to exporter: Disposal of unpaid goods

Risk to importer: Relies on exporter to shipgoods as described in documents


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Method : Drafts (Bills of Exchange)

* Time drafts (documents against acceptance):When the shipment has been made, the buyer

accepts (signs) the presented draft. Time of payment: On maturity of draft

Goods available to buyers: Before payment

Risk to exporter: Relies on buyer to pay

Risk to importer: Relies on exporter to shipgoods as described in documents


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Method :Consignments

The exporter retains actual title to the goods thatare shipped to the importer.

Time of payment: At time of sale to third party


Risk to exporter: Allows importer to sell

inventory before paying exporter Risk to importer: None


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Method : Open Accounts

The exporter ships the merchandise and expectsthe buyer to remit payment according to the

agreed-upon terms. Time of payment: As agreed upon


Risk to exporter: Relies completely on buyer to

pay account as agreed upon Risk to importer: None


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Trade Finance Methods

Accounts Receivable Financing An exporter that needs funds immediately

may obtain a bank loan that is secured

by an assignment of the account receivable.Factoring (Cross-Border Factoring)

The accounts receivable are sold to athird party (the factor), which, then assumes

all the responsibilities and exposureassociated with collecting from the buyer.


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Letters of Credit (L/C)

These are issued by a bank on behalf ofthe importer promising to pay the exporter

upon presentation of the shipping documents.

The importer pays the issuing bank theamount of the L/C plus associated fees.

Commercial or import/export L/Cs areusually irrevocable.


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The required documents typically include adraft (sight or time), a commercial invoice,

and a bill of lading (receipt for shipment).

Sometimes, the exporter may request thata local bank confirm (guarantee) the L/C.


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Variations include standby L/Cs: funded only if the buyer does not

pay the seller as agreed upon transferable L/Cs: the first beneficiary can transfer

all or part of the original L/C to a third party

assignments of proceeds under an L/C: the

original beneficiary assigns the proceeds to theend supplier


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Bankers Acceptance (BA) This is a time draft that is drawn on and

accepted by a bank (the importers bank). The

accepting bank is obliged to pay the holder ofthe draft at maturity.

If the exporter does not want to wait forpayment, it can request that the BA be sold in

the money market.Trade financing is providedby the holder of the BA.


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Bankers Acceptance (BA)

The bank accepting the drafts charges an all-in-rate (interest rate) that consists of the

discount rate plus the acceptance commission. In general, all-in-rates are lower than bank

loan rates. They usually fall between the

rates of short-term Treasury bills andcommercial papers.


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Life Cycle of a Typical Bankers

Acceptance

(P434 Exhibit 16.5)


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Working Capital Financing

Banks may provide short-term loans thatfinance the working capital cycle, from the

purchase of inventory until the eventualconversion to cash ( to the importer);and finance the manufacture of themerchandise destined for export or the timeperiod from when the sale is made untilpayment is received( to the exporter).


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Medium-Term Capital Goods Financing(Forfaiting)

The importer issues a promissory note to the

exporter to pay for its imported capital goodsover a period that generally ranges from threeto seven years.

The exporter then sells the note, withoutrecourse, to a bank (the forfaiting bank).


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Countertrade

These are foreign trade transactions in which thesale of goods to one country is linked to the

purchase or exchange of goods from that samecountry.

Common countertrade types include barter,compensation (product buy-back), and

counterpurchase. The primary participants are governments and

MNCs.


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Agencies that MotivateInternational Trade*

Due to the inherent risks of internationaltrade, government institutions and theprivate sector offer various forms of export

credit, export finance, and guaranteeprograms to reduce risk and stimulateforeign trade.


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Export-Import Bank of the U.S. (Ex-Imbank)

This U.S. government agency aims to createjobs by financing and facilitating the export of

U.S. goods and services and maintaining thecompetitiveness of U.S. companies in overseasmarkets.

It offers guarantees of commercial loans, directloans, bank insurance and export creditinsurance.


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PrivateExportFundingCorporation(PEFCO)

PEFCO is a private corporation that is owned by

a consortium of commercial banks and industrial

companies.

In cooperation with Ex-Imbank, PEFCO providesmedium- and long-term fixed-rate financing for

foreign buyers through the issuance of long-termbonds.


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Overseas Private Investment Corporation(OPIC)

OPIC is a U.S. government agency that assists

U.S. investors by insuring their overseasinvestments against a broad range of politicalrisks.

It also provides financing for overseasbusinesses through loans and loan guaranties.


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Questions and Applications

1. How can a bankers acceptance be beneficial

to an exporter? an importer? a bank?

2. Why would an exporter provide financing for an

importer? Is there much risk in this activity?

Explain.

3. What is the role of a factor in international

trade transactions? How can a factor aid an

exporter?


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4. What are bills of lading and how do

they facilitate international trade

transactions?5. What is forfaiting? Specify the type of

traded goods for which forfaiting is

applied.6. Describe how foreign trade would be

affected if banks did not provide

trade-related services.


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7. What is countertrade?

*8. This chapter described many forms of

government insurance and guarantee

programs . What motivates a governmentto establish so many programs?

9. Ocean Traders of North America is a firm

based in Mobile, Alabama, that specializes in

seafood exports and commonly uses

letters of credit (L/Cs) to ensure payment.


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It recently experienced a problem, however. OceanTraders had an irrevocable L/C issued by a Russianbank to ensure that it would receive payment uponshipment of 16,000 tons of fish to a Russian firm.

This bank backed out of its obligation, however,stating that it was not authorized to guaranteecommercial transactions.

a. Explain how an irrevocable L/C would normally

facilitate the business transaction between the

Russian importer and Ocean Traders of North America.


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b. Explain how the cancellation of the L/C

could create a trade crisis between the U.S.

and the Russian firms.

c. Why do you think situations like this( the cancellation of the L/C ) are rare in

industrialized countries?

d. Can you think of any alternative strategy that

the U.S. exporter could have used to protect

itself better when dealing with a Russian

importer?

international financial management 7

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