International Trade Payment Methods

International Trade Payment Methods. ASBDC Conference September 8, 2011. Understanding International Financial Risk. Commercial Sovereign or Political Foreign Exchange. Movement of Funds. SWIFT Society for Worldwide Interbank Financial Telecommunication Drafts Bank Sight Usance

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International Trade Payment Methods

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  1. International Trade Payment Methods ASBDC Conference September 8, 2011
  2. Understanding International Financial Risk • Commercial • Sovereign or Political • Foreign Exchange
  3. Movement of Funds • SWIFT • Society for Worldwide Interbank Financial Telecommunication • Drafts • Bank • Sight • Usance • Checks
  4. Foreign Exchange
  5. Foreign Exchange • An exchange of one currency for another currency • (i.e.) Dollars (USD) for Japanese Yen (JPY) • Indirect Quote (European) • 1 USD = 77.0599 JPY • Direct Quote (American) • 1 JPY = .0129769 USD
  6. Who uses Foreign Exchange • Tourists • Importers / Exporters • Investors • Speculators • Central Banks
  7. Local Currency Payment Western Europe Japan, Hong Kong, Singapore, Australia and New Zealand Canada, Mexico South Africa Thailand, Indonesia US$ Payment South America Eastern Europe China, Taiwan Africa Malaysia Which Currencies are Traded
  8. Instruments most commonly used to offset risk • Spot • Forwards (up to 1 year typically) • Futures • Swaps • Options
  9. Determinants of Spot Rate • Balance of Payments/Trade • Real rates of return • Current growth and growth prospects of the economy • Economic and political stability • Exchange restrictions, if any • Central Bank intervention
  10. Forward Contracts • Purchase or sale of one currency for another with delivery taking place on a specific future date or within a specific window of time • Unlike futures traded over-the-counter • Any convertible currency • Any maturity (typically less than a year) • Any amount (typically with a $50,000 min)
  11. Forward Contracts • Price is based on: • Current spot rate plus or minus a discount or premium for interest rate differentials • Determinants of Forward Rates • A currency is at a PREMIUM against another currency in the forward market when that other currency’s interest rate is higher • A currency is at a DISCOUNT against another currency in the forward market when that other currency’s interest rate is lower
  12. Options • The right but not the obligation to convert one currency for another on a specific future date. • Price is based on: • current spot price • strike price • volatility factor • Example: • The right to buy Japanese Yen at a specific rate one year out in the future. If the Yen weakens a conversion will be made in the open market.
  13. Forward Contract Eliminates up and downside potential Good tool when company has firm commitments in the future Mark-to-market offset against A/R or A/P No initial cost 10% risk assessment Option Eliminates “downside” but leaves “upside” Good tool for company involved in projects with uncertainty “Naked hedge” for commitments not yet recognized on the balance sheet 1-5% premium up front a tough sale Options vs Forward Contract
  14. Futures Contracts • Contracts for specific quantities of a given currency • Chicago Mercantile Exchange • Exchange rate fixed at time contract is entered into • Mark to Market • Daily settlement with profits or losses paid every day
  15. Advantages Smaller size Freedom to liquidate a contract anytime Disadvantages Limited number of currencies Limited delivery dates Rigid contractual amounts Futures versus Forwards
  16. Foreign Exchange Objectives • Maximize consolidated net after-tax cash flows without undue risk • Preserve US dollar value of cash flow • Minimize volatility in reported earnings • Maximize profitability
  17. Payment Methods
  18. International Payment Methods • Cash in Advance • Open Account • Documentary Collections • Letters of Credit
  19. Risk vs. Method of Payment Buyer Risk Seller Risk • Open Account • Documentary Collection • Letter of Credit • Cash in Advance Low High High Low
  20. Cash In Advance • Time of Payment • Before Shipment • Goods Available to Buyer • After Payment • Risks to Seller • None • When Appropriate • Seller has negotiating strength to demand cash in advance
  21. Open Account • Time of Payment • As agreed; i.e. 30 days • Goods Available to Buyer • Before Payment • Risks to Seller • Buyer defaults on payment obligation • Delays in availability of foreign exchange and transferring of funds from buyer’s country
  22. Open Account • When Appropriate • Seller has absolute trust that buyer will accept shipment and pay at agreed time • Seller is confident that importing country will not impose regulations deferring or blocking transfer of payment • Seller has sufficient liquidity or access to outside financing to extend deferred payment terms
  23. Benefits of Export Credit Insurance • Risk Mitigation • Political • Commercial • Market Penetration • Extended credit terms to foreign buyers • Relaxation of method of payment reducing bank costs and documentation • Financing • U.S. exporter can borrow against insured foreign receivables
  24. Documentary Collection Characteristics • Allows exporters to retain ownership of the goods until they receive payment or are reasonably certain they will receive it • Bank acts as agent for exporter by holding the title documents • Bank assumes no risk but must act in good faith and exercise reasonable care
  25. Documentary Collection Seller Buyer $ $ Documents Documents Documents $ Buyer’s Bank Seller’s Bank
  26. Draft or Bill of Exchange ______________________________________ ________________________________ NO.___________ (CITY) (DATE) AT _____________________________________________________ SIGHT OF THIS BILL OF EXCHANGE PAY TO THE ORDER OF ________________________________________ ___________________ (AMOUNT IN FIGURES) THE SUM OF___________________________________________________________________________ ______________________________________________________________________________________ TO ________________________________________ ______________________________________ DRAWER _________________________________________ _________________________________________ ______________________________________ DRAWEE BY: AUTHORIZED SIGNATURE
  27. Documentary Collection - D/P • Time of Payment • On presentation of sight draft by a bank to buyer • Goods Available to Buyer • After payment • Risks to Seller • Buyer’s nonacceptance of shipment • Payment delays due to unavailability of foreign exchange in buyer’s country • Payment blocked due to political actions in buyer’s country
  28. Documentary Collection - D/P • When Appropriate • Seller is confident that buyer will accept shipment • Seller is confident that importing country will not impose regulations deferring or blocking transfer of payment
  29. Documentary Collections - D/A • Time of Payment • At maturity of accepted draft • Goods Available to Buyer • Before payment • Risks to Seller • Buyer’s default on payment obligation • Delays in availability of foreign exchange and transferring of funds from buyer’s country • Payment blocked due to political events in buyer’s country
  30. Documentary Collections - D/A • When Appropriate • Seller has confidence that buyer will accept shipment and pay on agreed date • Seller is confident that importing country will not impose regulations deferring or blocking the transfer of payment
  31. Documentary Collections Risk • Unscrupulous buyer • Insolvent buyer • Buyer changes mind • Buyer’s country is in turmoil • Foreign exchange may not be available • Seller may have to pay return freight • Buyer may not honor promise to pay
  32. Letter of Credit • Letters of Credit (L/Cs) are legal instrumentsissued by banks (on behalf of their customers) with the conditional obligation to make payment to the beneficiary of the L/C • Documentary (Trade) Letters of Credit are used to facilitate payments in import and export transactions • Standby Letters of Credit are “Standing By” for an event of default or non-performance before they can be drawn on
  33. Advising Bank authenticates LC Confirming Bank guarantees payment if Issuing Bank defaults Applicant Buyer/Importer Beneficiary Seller/Exporter Issuing Bank Guarantees payment Letter of Credit – Key Parties
  34. Irrevocable ICC UCP 600 ISP 98 Incoterms Tenor Sight Usance Discrepancies L/C Terminology
  35. Uniform Customs and Practices for Documentary CreditsThe U.C.P. 600 (2007 Revision) • General provisions and definitions. • Form and notification of credits. • Liabilities and responsibilities of parties. • Documents of commerce. • Miscellaneous provisions. • Transferability of letters of credit.
  36. Commonly Used Documents • Commercial Invoice • Transport Document • Ocean Bill of Lading • Air Waybill • Packing Lists/Weight Lists • Insurance Policy or Certificate • Draft or Bill of Exchange • Other Documents • Inspection Certificate • Special Customs Invoices • Certificate of Origin
  37. Draft or Bill of Exchange ______________________________________ ________________________________ NO.___________ (CITY) (DATE) AT _____________________________________________________ SIGHT OF THIS BILL OF EXCHANGE PAY TO THE ORDER OF ________________________________________ ___________________ (AMOUNT IN FIGURES) THE SUM OF___________________________________________________________________________ ______________________________________________________________________________________ DRAWN UNDER ________________________________________________________________________ LC NO. ________________ DATED __________ TO ________________________________________ ______________________________________ DRAWER _________________________________________ _________________________________________ ______________________________________ DRAWEE BY: AUTHORIZED SIGNATURE
  38. Letter of Credit Issuance Contract Exporter Step 1 Importer Step 4 L/C Forwarded to Beneficiary with or without confirmation Application Made for Letter of Credit Step 2 Letter of Credit Forwarded by the Issuing Bank Issuing Bank in Importer’s City Advising Bank in Exporter’s City Step 3
  39. Letter of Credit Payment Step 3 Documents Issuing / Opening Bank Advising/ Confirming Bank Step 4 Step 2 Money Documents Money Documents Money Buyer Importer Account Party Seller/ Exporter Beneficiary Step 5 Step 1 Surrenders Bill of Lading Receives Goods Receives Bill of Lading Surrenders Goods Carrier
  40. Letter of Credit • Time of Payment • When LC calls for a sight draft - at time documents are presented to negotiating bank • When LC calls for a time (usance) draft - at maturity of accepted time draft • Goods Available to Buyer • When LC calls for a sight draft - after payment • When LC calls for a time draft - after draft has been accepted by bank
  41. Letter of Credit • Risks to Seller • Discrepancies in the documents • Buyer’s Bank (opening bank) defaults on its payment obligation • Payment blocked due to political events in buyer’s country • When Appropriate • Seller is unsure of creditworthiness of buyer
  42. Letter of Credit Variations • Back to Back • Assignment of Proceeds • Transferable • Revolving • Standby
  43. Standby Letter of Credit • Commercial documents generally flow outside the letter of credit (between buyer and seller). • Funds generally flow outside of a letter of credit (between buyer and seller). • These credits are “Standing By” for an event of default or non-performance before they can be drawn on.
  44. Standby Letter of Credit Financial Assures account party’s performance of a financial obligation, i.e., to pay an invoice by a certain date. Performance Assures account party’s performance of a non-financial contract obligation, i.e., to deliver products under a contract.
  45. Factors to Consider in Determining Payment Terms Under a Contract
  46. Other Financing Options • Countertrade • i.e. barter, counterpurchase, compensation • Factoring • Outright sale of short term receivables • Forfaiting • Outright sale of medium term (large) obligation
  47. International Trade Payment Methods Cassie Stiles cassstiles@yahoo.com

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