NEGOTIABLE INSTRUMENTS Banking 4/17/2017 NEGOTIABLE INSTRUMENTS 5 5.1 Types of Negotiable Instruments 5.2 Presenting Checks for Payment 5.3 Processing Checks 5.4 Changing Forms of Payment Chapter 5

Lesson 5.1 TYPES OF NEGOTIABLE INSTRUMENTS Banking 4/17/2017 Lesson 5.1 TYPES OF NEGOTIABLE INSTRUMENTS GOALS Define the term negotiable instrument Compare and Contrast different types of negotiable instruments Chapter 5

NEGOTIABLE INSTRUMENTS Banking 4/17/2017 NEGOTIABLE INSTRUMENTS What is negotiable? Negotiable means transferable – between two people What is an instrument? Any agreed-upon medium of exchange - usually refers to checks, drafts, bills of exchange, promissory notes Negotiable Instrument – commonly referred to as commercial paper Chapter 5

Defined as unconditional written orders or promises to pay money Banking 4/17/2017 Commercial Paper Defined as unconditional written orders or promises to pay money Checks, drafts, bills of exchange are all considered commercial paper Legitimacy and use governed by the Uniform Commercial Code (UCC) May be a bearer instrument or it may be an instrument with highly specified terms Bearer instrument – payable to the bearer - bearer is whoever holds the instrument Chapter 5

FORMS OF NEGOTIABLE INSTRUMENTS Banking 4/17/2017 FORMS OF NEGOTIABLE INSTRUMENTS Checks Drafts Bills of Exchange Promissory Notes Chapter 5

Most common form of negotiable instrument Banking 4/17/2017 CHECKS Most common form of negotiable instrument Preferred method of payment for many debts Offer convenience, safety, and a record of transactions Check use per person is beginning to decline – According to the FR – in 1979 approximately 85%of non-cash payments were made by check. In 2000 60% of non-cash payments were made by check Why? Use of electronic payments (i.e. have car payment or mortgage payment deducted from your checking account monthly – do not write a check. Chapter 5

Three-party instrument – similar to a check Banking 4/17/2017 DRAFTS Three-party instrument – similar to a check Order signed by one party (the drawer, or drafter) that is addressed to another party (the drawee) directing the drawee to pay to someone (the payee) the amount indicated on the draft. The payment may be at sight or immediately or at some defined time A check is special type draft. Terms for writers and receivers of drafts are the same as those used for checks Credit Unions often provide “share drafts” instead of checks for their members Chapter 5

Common form of internationally negotiable instrument Banking 4/17/2017 BILLS OF EXCHANGE Negotiable and unconditional written order addressed by one party to another Receiver of the bill must pay the specified sum or deliver specified goods on demand or at a specified time Common form of internationally negotiable instrument Examples of Bills of Exchange: check, draft, trade agreement Chapter 5

Banking 4/17/2017 PROMISSORY NOTES Written promise to pay at a fixed or determinable future time a sum of money to a specified individual – legally binding Two-party instruments - legally binding documents with many specified terms that vary widely Promissory Note – is a written promise to pay that is legally binding on the parties. (show bullet 1 first) Example of a promissory note – student loans Chapter 5

Specialized Forms of Commercial Paper Banking 4/17/2017 Specialized Forms of Commercial Paper Certified Check Personal check that has been accepted by the bank before payment Cashier’s Check Check bank draws on itself Money Order Draft issued by a post office, bank, or telegraph company Traveler’s Checks Certified Check – Ahead of time bank takes funds from depositors account and sets them aside until certified check presented for payment Cashier’s Check – individual would use if they did not have a checking account – you would pay the bank the amount and the bank would write a check from their account to the individual/business you specify Money Order – again used if you do not have a checking account or you need to send money to individual where a check would not be accepted. Example – traveling in a foreign country Traveler’s Checks – drawn by a well-known financial institution. Purchaser signs 2X – when buy them and when spend them. Payee has the ability to compare the two signatures. Reduces risk of carrying large of amount of cash and also reduces risk of payee not accepting a good check Chapter 5

Lesson 5.2 PRESENTING CHECKS FOR PAYMENT GOALS Identify elements of negotiability Identify and explain common forms of check endorsements

ELEMENTS OF NEGOTIABILITY Banking 4/17/2017 ELEMENTS OF NEGOTIABILITY Written Signature Unconditional promise or order Sum certain Payable on demand or at a defined time Words of negotiation Did you know….there is no legally prescribed form for a check. Can write a check on a piece of toilet paper or a t-shirt However – would be difficult to process in automated check processing systems – therefore, the American Bankers Association and the American national Standards Institute govern the size and placement of information on checks, as well as paper thickness, color, and security features. Signature – must be signed by a person capable of doing so – must be valid (can be done by machine/rubber stamp) Unconditional – no strings attached Sum Certain – must clearly state principal amount to be paid and it must be a monetary value Words of Negotiation – Pay to the order of…. Remember negotiation applies to the ability of the holder to obtain its value STOP – got to page 122 TEACH – Words of negotiation can affect the way in which an instrument’s value is obtained. How do these words of negotiation differ in the way they affect eh negotiation of the instrument. Chapter 5

Endorsement of the instrument allows it to be negotiated Banking 4/17/2017 ENDORSEMENT Endorsement of the instrument allows it to be negotiated Type of endorsements Blank endorsement Restrictive endorsement Special or full endorsement Qualified endorsement Blank – aka open endorsement – least secure – simply the signature of the holder Restrictive – limits the use of the instrument to a means specified by the endorser – example, For Deposit Only Special – transfers check to another specified party Qualified – Attempts to limit the liability of the endorser without limiting the negotiability of the instrument – example, Pay to the order of Mary Smith without recourse. In other words, if the check “bounces” the original payee is not liable to pay Chapter 5

IDENTIFICATION AND CHECK ACCEPTANCE Banks may require as much or as little identification to cash or deposit a check at they wish Banks may have different rules for customers and non-customers

Lesson 5.3 PROCESSING CHECKS GOALS Identify three key laws that make today’s check-clearing process possible Explain the sequence of events as a check is processed for payment

THE CHECK PAYMENT SYSTEM Banking 4/17/2017 THE CHECK PAYMENT SYSTEM Three key legislative acts Federal Reserve Act of 1913 - Created a national check collection system and other rules for payments Uniform Commercial Code of 1958 - Established consistent code for transactions, adopted by all 50 states, eliminated wide variation of legal regulation that could hamper national payment system Expedited Funds Availability Act of 1987 - Regulation CC - combat float abuse practiced by some banks Three key legislative acts critically affect the check processing system Float abuse – checks deposited – banks did not credit customer accounts until long after the checks had been paid by the banks on which they were drawn. Known as float – banks used to their advantage Chapter 5

STANDARD FEATURES OF PERSONAL CHECKS Banking 4/17/2017 STANDARD FEATURES OF PERSONAL CHECKS For simulation use only Maria Mills 12 River Street Pettisville, OH 43553-0177 Pettisville Bank Pettisville, Ohio 801 56-25 412 103 7943 000801 041200257 $ Pay to the order of Dollars Date For Check Number Date Payee Amount Amount Turn to page 116 for definition of parts Person writing the check is the drawer The bank is the drawee – funds are in that bank Like a draft the drawer directs the drawee to pay the payee Memo Signature Identification Numbers Account Number Chapter 5

CHECK PAYMENT AND PROCESSING Banking 4/17/2017 CHECK PAYMENT AND PROCESSING Drawer - You Payee – Best Buy Bank of America Wachovia You go to Best Buy and purchase a couple of CD’s – you pay for them by writing a check Best Buy deposits your check in their Wachovia account Wachovia sends your check to the Federal Reserve – the Federal Reserve credits Wachovia’s account for the amount of the check (NOTE: at this point Wachovia has been credited the amount of the check but Bank of America has not yet subtracted or deducted it from their funds – for a brief period both banks count the same funds – known as float) Federal Reserve sends the check to Bank of America and BOA pays the Federal Reserve the check amount BOA deducts the amount from your account Wachovia credits or adds the amount to Best Buy’s account Process can take 2 to 5 days Make sure students understand the concept of float Federal Reserve (or other intermediary) Chapter 5

Transit Number Created in 1910 by the ABA 9 digit number identifies the bank where account is held Aids in check processing procedure Printed at the bottom left-hand corner of a check A/K/A routing number, transit/routing number and ABA number

Other Terms Postdated check Stale check Returned check – bounced check NSF check – non-sufficient funds Stop Payment

Lesson 5.4 CHANGING FORMS OF PAYMENT GOALS Identify modern forms of payment systems Identify and explain how banks and other financial institutions use automated forms of payment

CONSUMER PAYMENTS Charge cards Credit cards Cash cards Debit cards Banking 4/17/2017 CONSUMER PAYMENTS Charge cards Credit cards Cash cards Debit cards Smart cards Don’t copy – more info to follow Chapter 5

CHARGE CARDS Account must be paid in full at the end of the month Charge cards, in effect, lend the amount of purchases for a month Originally charge cards were store cards, but eventually third-party companies formed networks of participating businesses to expand the market American Express is the most prominent national charge card.

CREDIT CARDS Consumers allowed to pay all or part of their bills each month and finance the unpaid balance Using a credit card involves two banks—the bank that issued the card and the retailer’s bank.

CASH CARDS Cash cards are commonly used at an automated teller machine (ATM). Consumers can get cash, make transfers and deposits, or perform other banking functions by inserting the card and entering a personal identification number (PIN).

DEBIT CARDS Transfer money from a person’s designated account to the account of the retailer A debit card allows an immediate point-of-sale (POS) transaction Consumer swipes card through a magnetic reader, enters a PIN, and authorizes transfer

SMART CARDS Credit, debit, or other types of cards with embedded microchips Microchips store values and use the embedded logic to change values and record transactions

FUTURE PAYMENT SYSTEMS E-checks Digitally guaranteed type of electronic check to be transmitted on the Internet Obstacles – security issues and mutual acceptability networks Electronic tokens Monetary system based on the exchange of digital money Obstacles – counterfeiting and resistance

BANK PAYMENTS Electronic funds transfer (EFT) Banking 4/17/2017 BANK PAYMENTS Electronic funds transfer (EFT) Common form - direct deposit Automatic payments – bank makes payments to specified recipient (reverse of direct deposits) Automated clearing houses (ACHs) – magnetic tapes with data exchanged between banks Online transfers Fedwire – run by Fed Reserve, handles transfers for federal funds, interbank dealings, and securities transactions Clearing House Interbank Payment System (CHIPS) EFT – example is direct deposit of payroll check – saves the overhead cost of processing checks Fedwire – In 2003 Fedwire handles about 430,000 transactions per day averaging 3.5 million each CHIPS – specializes in large-dollar transactions for international business. Chapter 5

Electronic check presentment (ECP) Banking 4/17/2017 THE LEADING EDGE Digital imaging Potential to save banks millions per year in storage, record keeping, postage, and labor costs Electronic check presentment (ECP) Device reads account info from magnetic ink Info immediately transmitted to the paying bank Process virtually eliminates bad checks and float Digital Imaging – digital photo of check saved versus saving the actual processed check Chapter 5