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Chapter 23
International Trade
Finance
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The Trade Relationship
Trade financing shares a number of common characteristics withthe traditional value chain activities conducted by all firms.
All companies must search out suppliers for the many goods andservices 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, deliversaid 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 paymentterms.
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The Trade Relationship
The nature of the relationship between the exporter andthe importer is critical to understanding the methodsfor import-export financing utilized in industry.
There are three categories of relationships (see nextexhibit):
Unaffiliated unknown
Unaffiliated known
Affiliated (sometimes referred to as intra-firm trade)
The composition of global trade has changeddramatically over the past few decades, moving fromtransactions between unaffiliated parties to affiliatedtransactions.
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Exhibit 23.1 Alternative International
Trade Relationships
UnaffiliatedKnown Party
A long-term customer
with which there is an
established relationship of
trust and performance
UnaffiliatedUnknown Party
A new customer
which with exporter has
no historical business
relationship
AffiliatedParty
A foreign subsidiary
or affiliate
of exporter
Requires:
1. A contract
2. Protection against
non-payment
Requires:
1. No contract
2. No protection against
non-payment
Requires:
1. A contract
2. Possibly some protection
against non-payment
Exporter
Importer is .
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The Trade Dilemma
International trade (i.e. between and importer andexporter) 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 honoringobligations
In essence, there could be distrust, and clearly theimporter and exporter would prefer two differentarrangements for payment/goods transfer (next exhibit)
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Exhibit 23.2 The Mechanics of Import and Export
Importer
Importer
Exporter
Exporter
Importer Preference
Exporter Preference
1st: Exporter ships the goods
2nd
: Importer pays after goods received
1st: Importer pays for goods
2nd: Exporter ships the goods after being paid
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The Trade Dilemma
The fundamental dilemma of being unwillingto trust a stranger in a foreign land is solved byusing a highly respected bank as an
intermediary. The following exhibit is a simplified view
involving a letter of credit(a banks promise topay) on behalf of the importer.
Two other significant documents are an orderbill of ladingand asight draft.
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Exhibit 23.3 The Bank as the Import/Export Intermediary
Importer
Exporter
Bank
1st: Importer obtains banks promise
to pay on importers behalf.
2nd: Bank promises exporterto pay on behalf of importer.
3rd
: Exporter ships to the banktrusting banks promise.
4th: Bank pays the
exporter.
6th: Importer pays
the bank.
5th: Bank gives merchandise
to the importer.
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Benefits of the System
The system (including the threedocuments discussed) has beendeveloped 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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Elements of an Import/Export
Transaction
Each individual trade transaction must cover threebasic elements: description of goods, prices, anddocuments regarding shipping and deliveryinstructions.
Contracts:
An import or export transaction is by definition a contractualexchange between parties in two countries that may havedifferent legal systems, currencies, languages, religions or
units of measure All contracts should include definitions and specifications for
the quality, grade, quantity, and price of the goods in question
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Elements of an Import/Export
Transaction
Prices:
Price quotations can be a major source ofconfusion
Price terms in the contract should conformto published catalogs, specify whetherquantity discounts or early paymentdiscounts are in effect, and state whether
finance charges are relevant in the case ofdeferred payment, and should address otherrelevant fees or charges
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Elements of an Import/Export
Transaction
Documents:
Bill of ladingissued to the exporter by a common carriertransporting the merchandise
Commercial invoiceissued by the exporter and contains a
precise description of the merchandise (also indicates unitprices, financial terms of the sale etc.)
Insurance documentsspecified in the contract of sale andissued by insurance companies (or their agents)
Consular invoicesissued in the exporting country by the
consulate of the importing country
Packing lists
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International Trade Risks
The following exhibit illustrates the sequenceof events in a single export transaction.
From a financial management perspective, the
two primary risks associated with aninternational trade transaction are currency risk(currency denomination of payment) and riskof non-completion(timely and complete
payment).
The risk of default on the part of the importeris present as soon as the financing period
begins.
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Exhibit 23.4 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
Negotiations Backlog
Documents Are
Presented
Cash
settlement
of the
transaction
F inancing Peri od
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Letter of Credit (L/C)
A letter of credit (L/C) is a banks conditionalpromise to pay issued by a bank at the requestof an importer, in which the bank promises to
pay an exporter upon presentation ofdocuments specified in the L/C.
An L/C reduces the risk of noncompletionbecause the bank agrees to pay against
documents rather than actual merchandise.
The following exhibit shows the relationshipbetween the three parties.
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Exhibit 23.5 Parties to a Letter of Credit (L/C)
I ssuing Bank
Beneficiary(exporter)
Applicant(importer)
The relationship between the importer and the
exporter is governed by the sales contract.
The relationship between the
importer and the issuing bank is
governed by the terms of the
application and agreementfor 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 bythat bank.
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Letter of Credit (L/C)
The essence of the L/C is the promise of the issuing bank to payagainst specified documents, which must accompany any draft drawnagainst the credit.
To constitute a true L/C transaction, all of the following five elementsmust be present with respect to the issuing bank:
Must receive a fee or other valid business consideration for issuingthe L/C
The L/C must contain a specified expiration date or definitematurity
The banks commitment must have a stated maximum amount of
money The banks obligation to pay must arise only on the presentation of
specific documents
The banks customer must have an unqualified obligation toreimburse the bank on the same condition as the bank has paid
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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 riskthe exporter can sell against a banks promise to payrather 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 thedocuments have arrived at the bank that issued the L/Cand after all conditions stated in the credit have beenfulfilled.
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Exhibit 23.6 Essence of a Letter of Credit (L/C)
Bank of the East, Ltd.[Name of I ssuing Bank]
Date: September 18, 2003
L/C Number 123456
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 123456.
The draft is to be accompanied by the following documents:
1. Commercial invoice in triplicate
2. Packing list3. 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.Authori zed Signature
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Draft
A draft, sometimes called a bill of exchange(B/E), isthe instrument normally used in internationalcommerce to effect payment.
A draft is simply an order written by an exporter(seller) instructing and 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 asthe maker, drawer, or originator.
Normally this is the exporter who sells and ships themerchandise.
The party to whom the draft is addressed is the drawee.
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Exhibit 23.7 Essence of a Time Draft
Name of ExporterDate: October 10, 2003
Draft number 7890
Ninety (90) days after sight of this First of Exchange, pay to the order of Bank
of the West [name of exporters bank] the sum of Five-hundred thousand U.S.
dollars for value received under Bank of the East, Ltd. letter of credit
number 123456.
Signature of Exporter
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Bill of Lading (B/L)
The third key document for financinginternational trade is the bill of ladingor 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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Exhibit 23.8 Steps in a Typical Trade Transaction
Exporter
Bank X Bank I
Importer
Public
Investor
1. Importer orders goods
2. Exporter agrees to fill order
6. Exporter ships goods to Importer
4. Bank I sends
L/C to Bank X
9. Bank I accepts draft, promising to pay in 60
days, and returns accepted draft to Bank X
7. Exporter presents
draft and documents
to its bank, Bank X
12. Bank I obtains
importers note
and releases shipment
3. Importer
arranges L/C
with its bank
13. Importerpays
its bank
8. Bank X presents draft and
documents to Bank I
5. Bank X
advises
exporter
of L/C 10. Bank X sells
acceptance to investor
14. Investor presents acceptance
and is paid by Bank I
11. Bank Xpays
exporter
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Government Programs
to Help Finance Exports
Governments of most export-oriented industrialized countrieshave special financial institutions that provide some form ofsubsidized credit to their own national exporters.
These export finance institutions offer terms that are better thanthose generally available from the competitive private sector.
Thus domestic taxpayers are subsidizing lower financial costs forforeign buyers in order to create employment and maintain atechnological edge.
The most important institutions usually offer export credit
insurance and a government-supported bank for export financing.
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Export Credit Insurance in India
Provided by Export Credit & GuaranteeCorporation of India (ECGC).
ECGC provides a range of services to
exporters against loss of goods.
Offers guarantees to banks and financialinstitutions which are involved in export
financing. Provided overseas investment insurance
to Indian companies investing abroad.
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EXIM Bank of India
Exim Bank of India, provides financial assistance to promoteIndian exports through:
1. Direct financial assistance,
2. Overseas investment finance,
3. Term finance for export production and export development,
4. Pre-shipping credit,5. Buyer's credit,
6. Lines of credit,
7. Relending facility,
8. Export bills redixcounting,
9. Refinance to commercial banks.10. The Exim Bank also extends non-founded facility to Indian
exporters in the form of guarantees.
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Setting Up EOUs
The Government amended in November 1983 aconcession scheme to facilitate the setting upof export-oriented units (EOUs) in order toenable them to meet requirements of foreign
demand in terms of pricing, quality, precisionetc.
EOUs can be set up anywhere in the countryand may be engaged in the manufacture and
production of software, floriculture,horticulture, agriculture, aquaculture, animalhusbandry, pisciculture, poultry and sericultureor other similar activities.
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Marketing Finance from EXIM Bank
Exim Bank seeks to create and enhance exportcapabilities and international competitivenessof Indian companies.
Under the lending programme for ExportMarketing Finance, the Banks addresses theterm finance reqirement for a structured andstrategic export marketing and development
effort of companies.
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Trade Financing Alternatives
In order to finance international tradereceivables, firms use the same financinginstruments as they use for domestic tradereceivables, plus a few specialized instrumentsthat are only available for financinginternational trade.
There are short-term financing instruments and
longer-term instruments in addition to the useof various types of barter to substitute for theseinstruments.
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Forfaiting
Forfaiting is a specialized technique to eliminate therisk of nonpayment by importers in instances where theimporting firm and/or its government is perceived bythe exporter to be too risky for open account credit.
The following exhibit illustrates a typical forfaitingtransaction (involving five partiesimporter, 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 ofexchange, or similar documents received from animporter in another country.
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Exhibit 23.10 Typical Forfaiting Transaction
Exporter(private industrial firm)
Importer(private firm or government
purchaser in emerging market)
FORFAITER(subsidiary of a
European bank)
Importers Bank(usually a private bank in
the importers country
Investor(institutional or individual)
Step 1
Step 3
Step 2
Step 7
Step 5
Step 4
Step 6
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Countertrade
The word countertraderefers to a variety ofinternational trade arrangements in which goods andservices are exported by a manufacturer withcompensation 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 casefinancing becomes important.
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International Trade Financing by
Commercial Banks in India.
Indian commercial banks offer Trade finance related fund needsfor both pre shipment and post shipment activities.
1. Various schemes to provide financing to exporters are as follows.
Rupee Export Credit (Pre-Shipment and Post-Shipment) Pre-Shipment Export Credit Post-Shipment Export Credit Pre-Shipment Credit in Foreign Currency (PCFC) Getting Started - Opening a PCFC Operating PCFC Export Bill Rediscounting
Letter of Credit2. Various schemes to provide financing to importers are as follows.
Foreign Currency import credit Supplier's credit
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