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 TRADE FINANCE LOGO Trade Finance Methods LOGO  Accounts Receivable Financing  An exporter that needs funds immediately may obtain a bank loan that is secured by an assignment of the account receivable  Factoring (Cross-Border Factoring)  The accounts receivable are sold to a third party (the factor), that then assumes all the responsibilities and exposure associated with collecting from the buyer Trade Finance Methods……contd LOGO  Letters of Credit (L/C)  These are issued by a bank on behalf of the importer promising to pay the exporter upon presentation of the shipping documents  The importer pays the issuing bank the amount of the L/C plus associated fees  Commercial or import/export L/Cs are usually irrevocable Trade Finance Methods……contd LOGO  Letters of Credit (L/C) The required documents typically include a draft (sight or time), a commercial invoice, and a bill of lading (receipt for shipment)  Sometimes, the exporter may request that a local bank confirm (guarantee) the L/C Ô Trade Finance Methodscontd LOGO  Letters of Credit (L/C)  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 LOGO  Banker’s Acceptance (BA)  This is a time draft that is drawn on and accepted by a bank (the importer’s bank) The accepting bank is obliged to pay the holder of the draft at maturity  If the exporter does not want to wait for payment, it can request that the BA be sold in the money market Trade financing is provided by the holder of the BA Trade Finance Methods……contd LOGO  Banker’s Acceptance (BA) The bank accepting the drafts charges an all-in-rate (interest rate) that consists of the discount rate plus the acceptance commission  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 Ô Trade Finance Methods……contd LOGO  Working Capital Financing  Banks may provide short-term loans that finance the working capital cycle, from the purchase of inventory until the eventual conversion to cash Trade Finance Methods……contd  Medium-Term Capital Goods LOGO Financing (Forfeiting)  The importer issues a promissory note to the exporter to pay for its imported capital goods over a period that generally ranges from three to seven years  The exporter then sells the note, without recourse, to a bank (the forfaiting bank) Trade Finance Methods……contd LOGO  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  Common countertrade types include barter, compensation (product buy-back), and counterpurchase  The primary participants are governments and multinationals LOGO TYPES OF GUARANTEE COUNTER GUARANTEE BANK A (Counter-guarantee issuing party) (2) (3) (7) (8) (4) (5) (6) (9) APPLICANT/ PRINCIPAL BANK B (Guarantor) (1) 21 BENEFICIARY TYPES OF GUARANTEE LOGO 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 the guarantor 22 TYPES OF GUARANTEE LOGO GUARANTEE CONFIRMATION BANK A (Guarantor) (2) APPLICANT/ PRINCIPAL (4) BANK B (Guarantee confirming party) (3) (5) (1) 23 BENEFICIARY TYPES OF GUARANTEE LOGO Co-guarantee: more than one bank participates in guarantee Co-guarantee parties shall assume joint responsibility to fulfill guarantee obligations unless otherwise agreed Where central credit institutions or foreign bank branches are required to fulfill guarantee obligations, involved 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 BANK GUARANTEE LOGO Question:  Differentiate types of bank guarantees?  Compare letter of credit and guarantee commitment? (Suggest comparative criteria: Purpose, meaning, obligations of issuer, field of application, Independence, Documents, amount, risk level arising ) 25 Chapter The Foreign Exchange Market LOGO The Bretton Woods Agreement An agreement reached in July 1944 between 44 countries to restructure the international financial system, post-war World War II Date GBP : USD 27 December 1945 £1.00 : US$4.03 18 September 1949 £1.00 : US$2.80 17 November 1967 £1.00 : US$2.40 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 US dollar 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 LOGO LOGO 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 15th 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 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 Source: http://www.xe.com LOGO Floating Exchange Rates LOGO With the end of the Bretton Woods system, most of the major currencies float against each other in value Date GBP : USD 27th December 1945 £1.00 : US$4.03 18th September 1949 £1.00 : US$2.80 17th November 1967 £1.00 : US$2.40 17th November 1977 £1.00 : US$1.82 17th November 1987 £1.00 : US$1.76 17th November 1997 £1.00 : US$1.69 17th November 2007 £1.00 : US$2.05 17th November 2008 £1.00 : US$1.50 17th November 2009 £1.00 : US$1.68 17th November 2010 £1.00 : US$1.59 17th November 2011 £1.00 : US$1.58 17th November 2012 £1.00 : US$1.59 17th November 2013 £1.00 : US$1.61 17th November 2014 £1.00 : US$1.56 Source: Bank of England 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 LOGO 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 LOGO Trading of foreign currencies clearly involves selling one currency and buying another, the two currencies involved are described as ‘pairs’ Base Currency The first currency quoted in a pair It is always equal to one unit of that currency Price at which a pair is bought and sold is the exchange rate : 0.75 In this case $1 is worth £0.75 When the exchange rate is being quoted, the name of the each currency is abbreviated to a three letter reference Most commonly quoted currency pairs: Counter or Quote Currency The second currency quoted in a pair LOGO 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 always In this case: If a client wants to buy £100,000 he will need to pay the higher of the two prices ($1.1166) and deliver $111,660 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 LOGO Currency Trading The forex market is primarily an over-thecounter (OTC) market, where brokers and dealers negotiate directly with each other London has grown to become the world’s largest forex market due to it’s ideal location between the Asian and American time zones 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 Types of FX transactions and financial instruments There are several types of transactions and financial instruments commonly used: Spot transaction The ‘spot rate’ is the rate quoted by a bank for the exchange 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) Forward transaction Money does not actually change hands until some agreed future date A buyer and seller agree on an exchange rate for any date in the future, for a fixed sum of money, 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 LOGO ... short-term Treasury bills and commercial papers Ô Trade Finance Methodscontd LOGO Working Capital Financing  Banks may provide short-term loans that finance the working capital cycle, from the purchase... assumes all the responsibilities and exposure associated with collecting from the buyer Trade Finance Methods……contd LOGO  Letters of Credit (L/C)  These are issued by a bank on behalf of... the L/C plus associated fees  Commercial or import/export L/Cs are usually irrevocable Trade Finance Methods……contd LOGO  Letters of Credit (L/C) The required documents typically include a