1. International Trade Finance
Chapter 20
International Trade Finance

2. PCL Questions Ilustrate trade activites normally carried out by MNE?
What is the risk of trade activities carried out by MNE?
How can MNE manage such trade risks?
What is meant by repositioning funds? How MNE can do it?
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3. The Trade Relationship
Trade financing shares a number of common characteristics with the traditional value chain activities conducted by all firms.
All companies must search out suppliers for the many goods and services required as inputs to their own goods production or service provision processes.
Issues to consider in this process include the capability of suppliers to produce the product to adequate specifications, deliver said products in a timely fashion, and to work in conjunction on product enhancements and continuous process improvement.
All of the above must also be at an acceptable price and payment terms.
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4. The Trade Relationship
The nature of the relationship between the exporter and the importer is critical to understanding the methods for import-export financing utilized in industry.
There are three categories of relationships (see next exhibit):
Unaffiliated unknown
Unaffiliated known
Affiliated (sometimes referred to as intra-firm trade)
The composition of global trade has changed dramatically over the past few decades, moving from transactions between unaffiliated parties to affiliated transactions.
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5. Exhibit 20.1 Alternative International Trade Relationships
Exporter
Unaffiliated
Unknown Party
A new customer
which with exporter has
no historical business
relationship
Unaffiliated
Known Party
A long-term customer
with which there is an
established relationship of
trust and performance
Affiliated
Party
A foreign subsidiary
or affiliate
of exporter
Importer is ….
Requires:
1. A contract
2. Protection against
non-payment
Requires:
1. A contract
2. Possibly some protection
against non-payment
Requires:
1. No contract
2. No protection against
non-payment

6. The Trade Dilemma
International trade (i.e. between and importer and exporter) must work around a fundamental dilemma:
They live far apart
They speak different languages
They operate in different political environments
They have different religions
They have different standards for honoring obligations
In essence, there could be distrust, and clearly the importer and exporter would prefer two different arrangements for payment/goods transfer (next exhibit)
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7. Exhibit 20.2 The Mechanics of Import and Export
1st: Exporter ships the goods
Importer
Importer Preference
Exporter
2nd: Importer pays after goods received
1st: Importer pays for goods
Importer
Exporter
Exporter Preference
2nd: Exporter ships the goods after being paid

8. The Trade Dilemma
The fundamental dilemma of being unwilling to trust a stranger in a foreign land is solved by using a highly respected bank as an intermediary.
The following exhibit is a simplified view involving a letter of credit (a bank’s promise to pay) on behalf of the importer.
Two other significant documents are an order bill of lading and a sight draft.
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9. Exhibit 20.3 The Bank as the Import/Export Intermediary
Importer
1st: Importer obtains bank’s promise
to pay on importer’s behalf.
6th: Importer pays
the bank.
2nd: Bank promises exporter
to pay on behalf of importer.
Bank
5th: Bank ‘gives’ merchandise
to the importer.
4th: Bank pays the
exporter.
Exporter
3rd: Exporter ships ‘to the bank’
trusting bank’s promise.

10. Benefits of the System
The system (including the three documents discussed) has been developed and modified over centuries to protect both importer and exporter from:
The risk of noncompletion
Foreign exchange risk
To provide a means of financing
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11. International Trade Risks
The following exhibit illustrates the sequence of events in a single export transaction.
From a financial management perspective, the two primary risks associated with an international trade transaction are currency risk (currency denomination of payment) and risk of non-completion (timely and complete payment).
The risk of default on the part of the importer is present as soon as the financing period begins.
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12. Exhibit 20.4 The Trade Transaction Time-Line and Structure
Time and Events
Price
quote
request
Export
contract
signed
Goods
are
shipped
Documents
are
accepted
Goods
are
received
Cash
settlement
of the
transaction
Negotiations
Backlog
Documents Are
Presented
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Financing Period

13. Key Documents: Letter of Credit (L/C)
A letter of credit (L/C) is a bank’s conditional promise to pay issued by a bank at the request of an importer, in which the bank promises to pay an exporter upon presentation of documents specified in the L/C.
An L/C reduces the risk of noncompletion because the bank agrees to pay against documents rather than actual merchandise.
The following exhibit shows the relationship between the three parties.
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14. Exhibit 20.5 Parties to a Letter of Credit (L/C)
Issuing Bank
The relationship between the
importer and the issuing bank is
governed by the terms of the
application and agreement
for the letter of credit (L/C).
The relationship between the
issuing bank and the exporter
is governed by the terms of the
letter of credit, as issued by
that bank.
Beneficiary
(exporter)
Applicant
(importer)
The relationship between the importer and the
exporter is governed by the sales contract.

15. Key Documents: Letter of Credit (L/C)
The essence of the L/C is the promise of the issuing bank to pay against specified documents, which must accompany any draft drawn against the credit.
To constitute a true L/C transaction, all of the following five elements must be present with respect to the issuing bank:
Must receive a fee or other valid business consideration for issuing the L/C
The L/C must contain a specified expiration date or definite maturity
The bank’s commitment must have a stated maximum amount of money
The bank’s obligation to pay must arise only on the presentation of specific documents
The bank’s customer must have an unqualified obligation to reimburse the bank on the same condition as the bank has paid
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16. Key Documents: Letter of Credit (L/C)
Commercial letters of credit are also classified:
Irrevocable versus revocable
Confirmed versus unconfirmed
The primary advantage of an L/C is that it reduces risk – the exporter can sell against a bank’s promise to pay rather than against the promise of a commercial firm.
The major advantage of an L/C to an importer is that the importer need not pay out funds until the documents have arrived at the bank that issued the L/C and after all conditions stated in the credit have been fulfilled.
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17. Exhibit 20.6 Essence of a Letter of Credit (L/C)
Bank of the East, Ltd.
[Name of Issuing Bank]
Date: September 18, 2003
L/C Number
Bank of the East, Ltd. hereby issues this irrevocable documentary Letter of Credit
to Jones Company [name of exporter] for US$500,000, payable 90 days after sight
by a draft drawn against Bank of the East, Ltd., in accordance with Letter of
Credit number
The draft is to be accompanied by the following documents:
1. Commercial invoice in triplicate
2. Packing list
3. Clean on board order bill of lading
4. Insurance documents, paid for by buyer
At maturity Bank of the East, Ltd. will pay the face amount of the draft to the
bearer of that draft.
Authorized Signature
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18. Key Documents: Draft
A draft, sometimes called a bill of exchange (B/E), is the instrument normally used in international commerce to effect payment.
A draft is simply an order written by an exporter (seller) instructing an importer (buyer) or its agent to pay a specified amount of money at a specified time.
The person or business initiating the draft is known as the maker, drawer, or originator.
Normally this is the exporter who sells and ships the merchandise.
The party to whom the draft is addressed is the drawee.
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19. Key Documents: Draft
If properly drawn, drafts can become negotiable instruments.
As such, they provide a convenient instrument for financing the international movement of merchandise (freely bought and sold).
To become a negotiable instrument, a draft must conform to the following four requirements:
It must be in writing and signed by the maker or drawer
It must contain an unconditional promise or order to pay a definite sum of money
It must be payable on demand or at a fixed or determinable future date
It must be payable to order or to bearer
There are time drafts and sight drafts.
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20. Key Documents: Bill of Lading (B/L)
The third key document for financing international trade is the bill of lading or B/L.
The bill of lading is issued to the exporter by a common carrier transporting the merchandise.
It serves three purposes: a receipt, a contract, and a document of title.
Bills of lading are either straight or to order.
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21. Documentation in a Typical Trade Transaction
A trade transaction could conceivably be handled in many ways.
The transaction that would best illustrate the interactions of the various documents would be an export financed under a documentary commercial letter of credit, requiring an order bill of lading, with the exporter collecting via a time draft accepted by the importer’s bank.
The following exhibit illustrates such a transaction.
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22. Exhibit 20.7 Steps in a Typical Trade Transaction
3. Importer
arranges L/C
with its bank
1. Importer orders goods
2. Exporter agrees to fill order
Exporter
Importer
5. Bank X
advises
exporter
of L/C
6. Exporter ships goods to Importer
7. Exporter presents
draft and documents
to its bank, Bank X
13. Importer
pays
its bank
12. Bank I obtains
importer’s note
and releases shipment
11. Bank X
pays
exporter
8. Bank X presents draft and
documents to Bank I
Bank X
Bank I
9. Bank I accepts draft, promising to pay in 60
days, and returns accepted draft to Bank X
10. Bank X sells
acceptance to investor
4. Bank I sends
L/C to Bank X
14. Investor presents acceptance
and is paid by Bank I
Public
Investor

23. Government Programs to Help Finance Exports
Governments of most export-oriented industrialized countries have special financial institutions that provide some form of subsidized credit to their own national exporters.
These export finance institutions offer terms that are better than those generally available from the competitive private sector.
Thus domestic taxpayers are subsidizing lower financial costs for foreign buyers in order to create employment and maintain a technological edge.
The most important institutions usually offer export credit insurance and a government-supported bank for export financing.
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24. Government Programs to Help Finance Exports
The exporter who insists on cash or L/C payment for foreign shipments is likely to lose orders to competitors from other countries that provide more favorable credit terms.
Competition between nations to increase exports by lengthening the period for which credit transactions can be insured my lead to a credit war and to unsound credit decisions.
In the United States, export credit insurance is provided by the Foreign Credit Insurance Association (FCIA), an unincorporated association of private commercial insurance companies operating in cooperation with the Export-Import Bank.
The Export-Import Bank of the U.S. (Eximbank) is another important agency of the U.S. Government established to facilitate the foreign trade of the United States.
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25. Trade Financing Alternatives
In order to finance international trade receivables, firms use the same financing instruments as they use for domestic trade receivables, plus a few specialized instruments that are only available for financing international trade.
There are short-term financing instruments and longer-term instruments in addition to the use of various types of barter to substitute for these instruments.
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26. Trade Financing Alternatives
Some of the shorter term financing instruments include:
Bankers Acceptances
Trade Acceptances
Factoring
Securitization
Bank Credit Lines Covered by Export Credit Insurance
Commercial Paper
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27. Forfaiting Forfaiting is a longer term financing instrument.
Forfaiting is a specialized technique to eliminate the risk of nonpayment by importers in instances where the importing firm and/or its government is perceived by the exporter to be too risky for open account credit.
The following exhibit illustrates a typical forfaiting transaction (involving five parties – importer, exporter, forfaiter, investor and the importers bank).
The essence of forfaiting is the non-recourse sale by an exporter of bank-guaranteed promissory notes, bills of exchange, or similar documents received from an importer in another country.
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28. Exhibit 20.9 Typical Forfaiting Transaction
Exporter
(private industrial firm)
Importer
(private firm or government
purchaser in emerging market)
FORFAITER
(subsidiary of a
European bank)
Importer’s Bank
(usually a private bank in
the importer’s country
Investor
(institutional or individual)
Step 1
Step 3
Step 2
Step 7
Step 5
Step 4
Step 6

29. Countertrade A countertrade is another longer term instrument.
The word countertrade refers to a variety of international trade arrangements in which goods and services are exported by a manufacturer with compensation linked to that manufacturer accepting imports of other goods and services.
In other words, an export sale is tied by contract to an import.
The countertrade may take place at the same time as the original export, in which case credit is not an issue; or the countertrade may take place later, in which case financing becomes important.
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30. Repositioning Funds
An MNE is constantly striving to create shareholder value by maximizing the after-tax profitability of the firm.
One dimension of this task is to reposition the profits of the firm, as legally and practically as possible, in low-tax environments.
Repositioning allows an MNE to increase after-tax profits by lowering its tax liabilities with the same amount of sales.
Repositioning is also useful when a MNE wishes to redeploy cash flows or funds to more value-creating activities or to minimize exposure to a potential currency collapse, or political or economic crises.
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31. Conduits for Moving Funds
Multinational firms often unbundle their transfer of funds into separate flows for specific purposes.
Unbundling allows a multinational firm to recover funds from subsidiaries without piquing host country sensitivities over large dividend drains.
The following exhibit illustrates conduits separated into before-tax ad after-tax groups in the host country.
Tax goals frequently are a critical determinant for many foreign subsidiary tax structures (making the before-tax, after-tax conduit distinction of importance).
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32. The End