Chapter5_Trade Finance Methods.pdf

LOGO Chapter 5 TRADE FINANCE LOGO 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[.]

Chapter 5

TRADE FINANCE

Trade Finance Methods

may obtain a bank loan that is secured by anassignment of the account receivable

party (the factor), that then assumes all theresponsibilities and exposure associated withcollecting from the buyer

 Letters of Credit (L/C)

importer promising to pay the exporter uponpresentation of the shipping documents

amount of the L/C plus associated fees

irrevocable.

Trade Finance Methods……contd

 Sometimes, the exporter may request that

a local bank confirm (guarantee) the L/C

Trade Finance Methods……contd

draft (sight or time), a commercial invoice,

and a bill of lading (receipt for shipment)

 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 the end supplier

Trade Finance Methods……contd

 Banker’s Acceptance (BA)

accepted by a bank (the importer’s bank) Theaccepting bank is obliged to pay the holder ofthe draft at maturity

payment, it can request that the BA be sold in

provided by the holder of the BA

Trade Finance Methods……contd

 In general, all-in-rates are lower than bank

loan rates They usually fall between the

rates of short-term Treasury bills and

commercial papers

Trade Finance Methods……contd

all-in-rate (interest rate) that consists of the

discount rate plus the acceptance

commission

 Working Capital Financing

finance the working capital cycle, from the

conversion to cash

Trade Finance Methods……contd

 Medium-Term Capital Goods Financing(Forfeiting)

exporter to pay for its imported capital goodsover a period that generally ranges from three

to seven years

recourse, to a bank (the forfaiting bank)

Trade Finance Methods……contd

 Countertrade

 These are foreign trade transactions in which the sale

of goods to one country is linked to the purchase or exchange of goods from that same country.

BANK GUARANTEE

1 Concept

Bank guarantee refers to a type of credit whereby the guarantor undertakes to act on behalf of the obligor to fulfill their financial obligations to the

obligee in the event the obligor fails to fulfill or

insufficiently fulfill their agreed-upon obligations to the obligee; the obligor must take on their debt

obligations and repay the guarantor

-12

BANK GUARANTEE

BENEFICIARY

ISSUING BANK (Guarantor)

APPLICANT/

PRINCIPAL

Underlying Transaction

Guarantee commitment: is a guarantee

document of the bank Including:

14

Letter of

Guarantee

Contract of Guarantee

BANK GUARANTEE

Letter of guarantee refers to the written

commitment between the guarantor and the

obligee to the guarantor's fulfilling the financial

obligation on behalf of the obligor in the event the obligor fails to fulfill or insufficiently fulfill agreed-upon obligations to the obligee

Under the counter guarantee or the guarantee

confirmation, the letter of guarantee shall include the written commitment of the counter-guarantee issuing party to the guarantee, or of the

guarantee-confirmation issuing party to the obligee

15BANK GUARANTEE

 Guarantee contract refers to the written

commitment between the guarantor and the obligee

and other related parties (if applicable) to the

guarantee’s fulfilling the financial obligation on behalf

of the obligor in the event the obligor fails to fulfill or

insufficiently fulfill agreed-upon obligations to the

obligee.

Under the counter guarantee or guarantee

confirmation, the guarantee contract shall be composed

of the written committee between the counter-guarantee issuing party and other related parties (if applicable), or between the guarantee-confirmation issuing party and the obligee as well as other related parties (if applicable).

16BANK GUARANTEE

Direct Guarantee Indirect Guarantee

TYPES OF BANK GUARANTEE

Based on the method of guarantee

The guarantee issuing bank is responsible directly to the guaranteed party and the guaranteed is responsible for directly

reimbursing the guarantee issuing bank.

The guarantee bank has issued a guarantee under the direction of an intermediary bank for the

guaranteed party based on another guarantee called counter guarantee The guaranteed party does not have

to reimburse directly to the guarantee issuing bank but the intermediary bank is responsible for reimbursement

 Credit Guarantee (Credit Line/Facility Guarantee)

 Payment Guarantee ( Financial Guarantee)

 Advance Payment Guarantee (Down Payment Guarantee)

 Bid Guarantee (Bid Bond, Tender Bond, Tender Guarantee)

 Performance Bond ( Performance Guarantee, Delivery Guarantee)

 Warranty Guarantee (Warranty bond)

 Retention Money Bond ( Retention Money Guarantee)

 Shipping Guarantee (Indemnity for lost B/L)

Counter guarantee: a type of bank guarantee

under which the counter-guarantee issuing

party agrees to fulfill the financial obligation to the guarantor in the event that the guarantor is called upon to fulfill the financial obligation on behalf of the obligor being the customer of the counter-guarantee issuing party; the obligor

must take on their debt obligations and repay the counter-guarantee issuing party

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TYPES OF GUARANTEE

COUNTER GUARANTEE

(8) (7)

(6) (5)

(4) (3)

(1)

BANK B (Guarantor)

APPLICANT/

PRINCIPAL

(9) (2)

Guarantee confirmation: a type of bank

guarantee under which the party issuing the bank

guarantee confirmation makes a contractual

agreement with the obligee to ensure that the

guarantor would perform their obligations to the

obligee The party issuing the bank guarantee

confirmation shall act on behalf of the guarantor to

fulfill their financial obligations in case of the

guarantor's nonperformance or insufficient

performance; the guarantor must take on their debt

obligations and repay the party issuing the bank

guarantee confirmation Meanwhile, the obligor must take on their debt obligations and make repayment to

TYPES OF GUARANTEE

GUARANTEE CONFIRMATION

BANK A

(Guarantor)

23TYPES OF GUARANTEE

Co-guarantee: more than one bank participates in

parties shall be responsible for paying these credit

institutions or foreign bank branches a sum equivalent to the agreed-upon co-guarantee contribution ratio.

24

TYPES OF GUARANTEE

Question:

Chapter 6

The Foreign Exchange Market

The Bretton Woods Agreement

An agreement reached in July 1944 between

44 countries to restructure the international

financial system, post-war World War II.

The US Dollar become the world’s

central currency, linked to the value

of gold The exchange rates of most

major currencies were fixed against

The agreement prevented countries from devaluing their currencies to

seek an unfair trade advantage.

World trade among developed countries grew

rapidly in the 1950s and 1960s, boosting world

output and raising the standard of living,

especially in Europe and Japan

The demise of Bretton Woods

By the 1970s, the cost of the Vietnam War and the

running of trade deficits put the US Dollar under pressure.

This led to a steady flow of US dollars (and therefore gold)

out of the US By 1971, the US only had reserves of gold

sufficient to cover 22% of the US dollars in issue

 It has been estimated that the true market price of gold in 1971

should have been US$103 per ounce

 Before the collapse of Bretton Woods, the French central bank was

buying US dollars with French francs, and converting the US dollars into

gold at US$35 per ounce

15 th August 1971, President Nixon announces the end of the gold standard for the US dollar

Nixon ends gold standard

Introducing the Foreign Exchange

Market

The foreign exchange market refers to the trading of one currency

for another.

It is by far the busiest and most active of the financial markets, with

turnover comfortably exceeding that of bonds and equities.

It is also known as:

 The forex market

 The FX market Source: http://www.xe.com

Most currencies are allowed by their

central banks to “float” - exchange rates

between one currency and another can

vary.

The value of one currency versus another

will depend on the economic health of

the issuer

This creates risks for companies operating

internationally

Floating Exchange Rates

With the end of the Bretton Woods system, most of the

major currencies float against each other in value.

Some currencies are still fixed (or

“pegged”) against another major currency:

 Jordan, Bahrain, Lebanon, Oman, Qatar, Saudi Arabia, UAE, Hong Kong all peg their currencies to the US dollar

 Morocco, Senegal, Ivory Coast, Cameroon, New Caledonia, all peg their currencies to the euro

Until 2005, China pegged the yuan to the US dollar, but now allows it to

fluctuate within a narrow band

Floating Exchange Rates

Changes in market demand and market supply of a currency cause a change in value

A rise in the demand for sterling (perhaps caused by a rise in exports

or an increase in the speculative demand for sterling) leads to an appreciation in the value of the pound.

Changes in currency supply also have an effect In the diagram above there is an increase in currency supply (S1-S2) which puts

downward pressure on the market value of the exchange rate.

Currency Quotes

Trading of foreign currencies clearly involves selling one

currency and buying another, the two currencies involved

are described as ‘pairs’

Price at which a pair is bought and sold

is the exchange rate

When the exchange rate is being quoted, the name of the each

currency is abbreviated to a three letter

The second

currency quoted

in a pair

1 : 0.75

In this case $1 is worth £0.75

Most commonly quoted currency pairs:

Currency Quotes

When currency pairs are quoted, the foreign exchange

trader will quote a bid and ask price:

1.1164/66

When quoting, the base

currency is not mentioned

as the convention is that

the base currency is

If a client wants to sell £100,000 he will need

to pay the lower of the two prices ($1.1164)

and receives $111,640

The forex market is primarily an

over-the-counter (OTC) market, where brokers and

dealers negotiate directly with each other.

Continually provide the market with both bid

(buy) and ask (sell) prices

Use the market to try to control money supply, inflation and interest rates.

Individual forex traders (i.e retail investors) are becoming increasingly important in the

global forex market.

Currency Trading

London has grown to become the world’s

largest forex market due to it’s ideal location

between the Asian and American time zones

Types of FX transactions and financial

instruments

of one currency for another with immediate effect.

Trades are technically ‘settled’ (currencies actually change

hands and arrive in recipients’ bank accounts) two business

days after the transaction date (T+2).

There are several types of transactions and financial

instruments commonly used:

1 Spot transaction

2 Forward transaction

Money does not actually change hands until

some agreed future date

A buyer and seller agree on an exchange rate for

and the transaction occurs on that date,

regardless of what the market rates are then.

The duration of the trade can be a few days,

months or years.