1. Financing International Trade
Lecture 13
Financing International Trade

2. Important Information
Last Exam:
Wednesday, December 3rd
150 points
Chapters 11, 12, 13, 15, 18, 19, and 23
Lecture 1 – 13
Research papers (general themes)
Review Session:
Monday, December 1st
Office Hours:
Tuesday: 1 – 3 (No office hours the rest of the week)

3. Definition
Import or export transaction: a contractual exchange involving goods/services for money between parties in two countries that may have:
different legal systems,
currencies,
cultures

4. Viewing International Trade Finance Issues
Financing Trade: The Flow of Goods and the Flow of Funds
Domestic Supplier
(US)
Domestic Buyer
EXPORTING
Canadian Buyer
IMPORTING
Mexican Supplier
Trident Corp.
(Los Angeles)
Goods & Services Flow from Supplier to Trident to Buyer
Goods & Services Flow from Supplier to Trident to Buyer
US$
Mexican Pesos
US$
Canadian $

5. Two Issues Facing Firm Foreign Exchange Exposure: Risk of Default
Importing (Accounts Payable)
Problem if the foreign currency strengthens
Hedge with a forward purchase
Exporting (Accounts Receivable)
Problem if the foreign currency weakens
Hedge with a forward sale
Risk of Default
Not receiving goods ordered/paid for!
Not receiving payments for goods shipped/sold!

6. International Trade Risks: Exporter
The Trade Transaction Timeline
Time and Events
Price
Quote
request
Export
contract
signed
Goods
are
shipped
Documents
are
accepted
Goods
are
received
Cash
settlement
of the
transaction
Negotiation
Production
Documents are
presented
Financing Period

7. International Trade Possibilities
International trade takes place between three categories of relationships:
affiliated parties (subsidiaries of parent)
unaffiliated unknown parties
unaffiliated known parties
Trade transactions between affiliated parties typically do not require contractual arrangements or external financing.
Trade transactions between unaffiliated parties typically do require contractual arrangements as well as some type of external financing such as letters of credit

8. International Trade Finance
Trident as an Exporter
Affiliated Party
Unaffiliated Known
Party
Unaffiliated Unknown
Importer is…
This is a new customer which Trident has no historical business relationship with
Requires:
A contract
Protection against non-payment
This is a Long-term customer with which there is an established relationship of trust and performance
Requires:
A contract
Possible protection against non-payment
This is a foreign subsidiary of Trident, a business unit of Trident Corporation
Requires:
No contract
No protection against non-payment

9. Basic Elements of an Import/Export Transaction
Each individual export sales transaction covers three basic elements:
The Contract: description of goods (quantity, grade, quality, technical details, payment instructions).
Prices (do they include shipping charges insurance fees), and
Documents regarding shipping and delivery instructions. These include:
Bills of lading (B/L) – is issued to the exporter by a common carrier transporting the merchandise
Commercial invoice – is issued by the exporter and contains a precise description of the merchandise. Unit prices, financial terms of sale, and amount due from the importer are indicated such as “FOB” (free on board), “FAS” (free alongside), “CFR” (cost & freight), or “CIF” (cost, insurance, freight)

10. Still More Documents
Insurance documents – must be as specified in the contract of sale and must be issued by insurance companies or their agents.
Consular invoices – issued in the exporting country by the consulate of the importing country to provide customs information and statistics for that country and to help prevent false declarations of value
Packing lists – may be required so that the contents of containers can be identified, either for customs purposes or for importer identification of the contents of separate containers

11. Additional Elements of an Import/Export Transaction
Shipping deadline – most importers insist on a specified deadline or time interval by which the shipment will be made
Payment instructions – which of the parties, exporter or importer, is to pay such charges as freight, insurance, import duties, handling fees, taxes, etc., must be carefully specified in the sales contract
Packaging and marking – depending on the nature of the goods, proper packaging may be critical to preserving and protecting items being shipped
Warranties, Guarantees, and inspection – assurances regarding the performance or qualities demonstrated by the goods from the exporter may also be included in the sales contract

12. Financing Trade Sales
Over many years, established procedures have arisen to finance international trade.
The basic procedure rests on the interrelationship between three key documents:
The letter of credit (L/C)
The draft, and
The bill of lading
Variations in each type of these three documents provide a variety of ways to accommodate any type of transaction

13. Financing Trade Sequence
In the simplest transaction, in which all three documents are used, an importer applies for and receives a L/C from its bank
In the L/C, the bank substitutes its credit for that of the importer and promises to pay if certain documents are submitted to the bank. The exporter may now rely on the promise of the bank rather than that of the importer
The exporter typically ships on an order bill of lading, i.e., attaches the bill of lading to a draft ordering payment from the importer’s bank and presents these documents, plus any additional documents, through its own bank to the importer’s bank

14. Letter of Credit
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
The essence of an L/C is the promise of the issuing bank to pay against specified documents, which means that certain elements must be present for the bank
Issuing bank must receive a fee for issuing L/C
Bank’s L/C must contain specified maturity date
Bank’s commitment must have stated maximum amount
Bank’s obligation must arise only on presentation of specific documents
Bank’s customer must have unqualified obligation to reimburse bank on same condition of bank’s payment

15. A Draft
A draft, sometimes called a bill of exchange (B/E), is the instrument normally used in international commerce to effect payment
It is a written order by an exporter instructing an importer or its agent to pay a specified amount at a specified time
The party initiating the draft is the maker, drawer, or originator while the counterpart is the drawee
In a commercial transaction where the buyer is the drawee it is a trade draft, or the buyer’s bank when it is called a bank draft

16. Banker’s Acceptances
If the documents are in order, the importer’s bank either pays the draft (sight draft) or accepts the draft (time draft). In the latter case, payment is at a future date.
At this step the importer’s bank acquires title to the merchandise through the bill of lading and releases it to the importer against a promise to pay
If a sight draft is used, the exporter is paid at once, if a time draft is used the exporter receives the accepted draft, now called a banker’s acceptance, back from the bank and holds it until maturity or sells it at a discount

17. Bankers’ Acceptance Banker’s Acceptance
When a draft is accepted by a bank, it becomes a banker’s acceptance
Example: Acceptance of $100,000 for exporter
Face amount of acceptance $100,000
Less 1.5% p.a. commission for 6 months
Amount received by exporter in 6 months $ 99,250
Less 7% p.a. discount rate for 6 months ,500
Amount received by exporter at once $95,750
Exporter may discount the acceptance note in order to receive the funds up-front

18. Bill of Lading
Bill of Lading (B/L) is issued to the exporter by a common carrier transporting the merchandise
It serves the purpose of being a receipt, a contract and a document of title
As a receipt the B/L indicates that the carrier has received the merchandise
As a contract the B/L indicates the obligation of the carrier to provide certain transportation
As a document of title, the B/L is used to obtain payment or written promise of payment before the merchandise is released to the importer

19. Protection of Parties
The three key documents noted in the previous slides have been crafted over time to protect all parties involved in a trade transaction.
These documents serve to determine who bears the financial loss if one of the parties defaults at any time
Risk of non-completion – once both parties agree to terms, they each want assurance that other party will complete its portion of the transaction
Financing the trade – some is required typically so parties must secure financing through a bank which acts as an intermediary utilizing the three key documents

20. Example of a Trade Transaction
Example: Assume Trident receives order from Canadian buyer; Trident will export financed under L/C requiring a bill of lading with exporter collecting a time draft accepted by Canadian buyer’s bank
The Canadian buyer places order with Trident
Trident agrees to ship under L/C
Canadian buyer applies to bank (Northland Bank) for L/C to be issued in favor of Trident for merchandise
Northland Bank issues L/C in favor of Trident and sends it to Southland Bank (Trident’s bank)

21. Example of a Trade Transaction
Trident ships the goods to the Canadian buyer
Trident prepares a time draft and presents it to Southland Bank. The draft is drawn on Northland Bank with required documents including bill of lading
Trident endorses the order bill of lading in blank so that title to goods goes with holder of documents – Southland Bank
Southland Bank presents draft and documents to Northland Bank for acceptance, Northland accepts and promises to pay draft at maturity – 60 days

22. Example of a Trade Transaction
Northland Bank returns accepted draft to Southland Bank; Southland Bank could ask for discounted draft receiving funds today
Southland Bank, now having a banker’s acceptance, may sell the acceptance in the open market or it may hold the acceptance in its own portfolio
If Southland Bank had kept the acceptance, it would transfer the proceeds less commission to Trident

23. Example of a Trade Transaction
Northland Bank notifies Canadian buyer of arrival of documents; Canadian buyer signs note to pay Northern Bank for the merchandise in 60 days
After 60 days, Northland Bank receives payment from Canadian buyer
On same day, holder of matured acceptance presents it for payment and receives it face value; it may be presented at Northland Bank or returned to Southland Bank for collection through normal bank channels

24. Complete Trade Transaction
1. Canadian Buyer orders goods
Northland Bank
3. Canadian buyer arranges L/C with bank
Trident
(exporter)
Canadian Buyer
(importer)
2. Trident agrees to fill order
5. Southland advises Trident of the L/C
6. Trident ships goods to Canadian buyer
11. Southland pays Trident
7. Trident presents draft & documents to its bank
12. Northland obtains Canadian buyer’s note and releases shipment
13. Canadian buyer pays bank
8. Southland presents draft & documents to Northland
Southland Bank
4. Northland Bank sends L/C to Southland Bank
9. Northland accepts draft, promising to pay in 60 days and returns acceptance to Southland
Public
Investor
10. Southland sells acceptance to investor
14. Investor presents acceptance for payment

25. Government Programs to Help Finance Exports
Export Credit Insurance
Provides assurance to the exporter or the exporter’s bank that an insurer will pay should the foreign customer default
In the US the Foreign Credit Insurance Association (FCIA) provides this type of insurance
Export-Import Bank
Known as the Eximbank, it facilitates the financing of US exports through various loan guarantee and insurance programs