Based on International Trade Administration (ITA) : Trade Finance Guide, April 2008

International Trade Finance

1. International Trade 2. Method of Payments
a. b. c. d. Cash in Advance Letter of Credits Documentary Collection Open Account :
Export Working Capital Financing Government-guaranteed EWC Programs Export Credit Insurance Export Financing

3. Countertrade 4. Forfaiting 5. Government Assistance in Exporting

Important Terms
Beneficiary : the recipients of funds or other benefits (exporter) Irrevocable : Incapable of being retracted or revoked Time Draft : a written order instructing the importer or the importer bank to pay the amount specified on its face on a certain date. A bill of lading : a document issued by the common carrier specifying that it has received the goods for shipment, it can serve as title to the goods. Banker Acceptance (B/A) : a negotiable money market instrument for which a secondary market exists.

1. International Trade
The trade/exchange of capital, goods, and services across international borders or territories.*

International trade is typically more costly than domestic trade. Why?

Because : the border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture.

*Sources : http://en.wikipedia.org/wiki/International_trade

2. Methods of Payment
Open Account Documentary Collection Letters of Credit Cash-inAdvance

Least Secure

Exporter

Importer

Most Secure

Cash-inAdvance

Letters of Credit

Documentary Collection

Open Account

Payment Method should be chosen carefully to minimize the payment risk, while also accomodating the buyers need.

For exporter, any sales is a GIFT until payment is received (they want to receive payment as soon as possible, as an order is places before the goods are sent to the importer) For importer any payment is DONATION until the goods are received (they want to received the goods as soon as possible and delay payment as long as possible, preferably until the goods are the resold and generate enough income to pay the exporter)

2a. Cash-in-Advance
Payment in advance trough credit card / banks check / wiretransfer before the ownership of the goods is transferred. Applicable for high-risk trade relationships and ideal for internet-based businesses.

Advantages : 1. Payment before shipment 2. Eliminates risk of non-payment 3. No risk for exporter

Disadvantages : 1. May lose customer to competitors over payments terms 2. No additional earnings trough financing operation 3. High risk for importer

2b. Letters of Credit (LC)

A commitment by a bank on behalf of the buyer that payment will be made to the beneficiary (exporter) provided that the terms and conditions stated in the LC have been met. Applicable for use in new or less-established trade relationships when the exporter is satisfied with the creditworthiness of the buyer bank.
Advantages : 1. Payment made after shipment 2. A variety of payment, financing, and risk mitigation options available.

Disadvantages : 1. Complex and laborintensive process 2. Relatively expensive method in terms of transaction costs

Risk evenly spread between seller and buyer, provided that all terms and conditions are adhered to.

Fact about LC
LC is a separate contract from the sales contract. (the bank is not concerned whether each party fulfill the terms in sales contract or not). The bank obligation to pay is solely conditioned upon the sellers compliance with the terms and conditions of the LC (bank only deal in document, not goods). LC can be arranged easily for one-time deals LC is always irrevocable (may not be changed or cancelled unless the seller agrees)

Process of a Typical Foreign Trade Transaction

1
Importer Purchase order Exporter

5
B/A 12

Shipment of goods

Money Market Investor 15 B/A presented at maturity

10 11 14

13

16

3
Importers Bank

Letter of Credit
Shipping Documents and

time draft accepted

Payment-discounted value of B/A

Exporters Bank

Importer (USA)
5
11

Exporter (China)
4 9

14

10

2 7

Importers Banks
15 13

Exporters Banks 8

Prior to B/A Creation

12

Money Market Sector

16

At and just after B/A creation At maturity date of B/A

Explanation of Importing sewing machine from China:

1. USA importer want to buy 1000 sewing machine from china. They are looking for any sewing machine producer that want to ship it under an LC to USA. After they find an exporter that agree with it, they will placing an order to them and Chinese exporter will inform the price and other terms of sale. Suppose the price of 1 sewing machine is 1000 RMB or equal to US$ 158, so the total face value of LC is 1000 x RMB 1000 = RMB 1,000,000 or US$ 158,000 (US$ 158 x 1000). 2. USA importer will apply to their bank for a letter of credit for the merchandise and providing the terms of sale. 3. LC sent via the USA bank to the China bank. 4. LC arrived in the China bank and the bank will notify the exporter.

5. The chinese exporter will ship the machine to USA. 6. After shipping the sewing machine, Chinese exporter will present to their bank a (60-day) time draft, a bill of lading, invoice and packing list. 7. The China bank presents the shipping documents and the time drafts to the USA bank. The USA bank accept the time draft and make a bankers acceptance and charges an acceptance commission which is deducted at the time of final settlement. This commission is based on the term-to-maturity of the time draft and creditworthiness of the importer. 8. Chinese exporter has a choice to hold the B/A until the maturity date or sell it at a discount price. Since the risk is similar and B/A trade rate is similar to the deposit rate of other bank. Suppose Chinese exporter instruct their bank to have the B/A discounted by the USA bank.

9. USA bank pay that amount of discounted B/A. 10. USA importer signs a (60-day) promissory note with USA bank for the face value of the B/A, due on the maturity date. 11. China Bank provides the auto-dealer with the shipping documents needed to take possesion of the sewing machines. 12. If B/A is no t held by Chinese exporter or China Bank, USA bank may hold it until maturity date and collect face value from the USA importer via promissory note. So USA bank may sell the B/A in the money market to investor. 13. An investor will buy it at a discount price from face value. 14. USA bank will collect the face value of the B/A via the promissory note 15. The money market investor will present the B/A for payment to USA bank 16. USA bank will pay the face value of B/A to the investor.

Formula
Maturity Value : = Face Value x [1-(commission x days/360) Discounted Value : = Face Value x [1-{(B/A rate + Commission Rate) x days/360}] Commission Accepted : = Face Value Maturity Value Bond equivalent yield : = {(maturity value/discounted value)-1} x (365/days)

How to calculate the Banker Acceptance?

1. Suppose the face amount of a promissory notes is $1,000,000 and the importer bank charges an acceptance commission of 1.5 percent. The note is for 60 days, so, a. How much the exporter would get if he decide to hold B/A until maturity and if they discounted the B/A? b. How much the bank commission ? Answer : a. If Chinese exporter wants to hold B/A until maturity, we can use this formula : Maturity Value = Face Value x [1-(commision x days/360) = $ 1,000,000 x [1-(0.15x60/360) = $ 997,500

But if chinese exporter wants to discount the B/A with USA bank, they will receive : = $ 1,000,000 x [1-{(0.525 + 0.0150) x (60/360)}] = $ 988,750 Regardless the chinese exporter want to hold the B/A to maturity or not, they have to pay the bank commission. The importer bank commission is : Face Value Maturity Value : = $1,000,000 - $997,500 = $ 2,500

The bond equivalent yield at maturity date is : = {($ 1,000,000/$ 988,750-1) x 365/60} = 0,0692 = 6,92% ( note : 365 is the actual number of days in the year, instead of bankers day) The bond equivalent rate the exporter received from discounting B/A is = {(($997,500/$998,750)-1)x365/60} = 0,0538 = 5,38% If the opportunity cost of capital is greater than 5,38%, discounting makes sense, if not, Chinese exporter should hold it until maturity.

Uniform Customs and Practice for Documentary Credits (UCP)

The Uniform Customs and Practice for Documentary Credits (UCP) is a set of rules on the issuance and use of letter of credits. The UCP is utilized by bankers and commercial parties in more than 175 countries in trade finance. Some 11-15% of international trade utilizes letters of credit, totaling over a trillion dollars (US) each year. UCP has been standardized by the ICC (International Chamber of Commerce) by publishing the UCP in 1933 and subsequently updating it throughout the years. The ICC has developed the UCP by regular revisions, the current version being the UCP600.

Fact about ICC

A significant function of the ICC is the preparation and promotion of its uniform rules of practice. The ICCs aim is to provide a codification of international practice occasionally selecting the best practice after ample debate and consideration. The ICC rules of practice are designed by bankers and merchants and not by legislatures with political and local considerations. The rules accordingly demonstrate the needs, customs and practices of business. Because the rules are incorporated voluntarily into contracts, the rules are flexible while providing a stable base for international review, including judicial scrutiny. The Certified Documentary Credit Specialist is a qualification awarded by IFSA US and IFS UK and endorsed by ICC Paris as the only International qualification for Trade Finance Professionals, recognizing the competence, and ensuring best practice.

2c. Documentary Collections

A transaction whereby the exporter entrust the collection of payment to the remitting bank (exporter bank), which sends documents to a collecting bank (importer bank), along with instruction for payment. Applicable for established trade relationships and in stable export markets. Advantages : There is a bank assistance in obtaining payments The process is simple, fast and lest costly than LCs Disadvantages : Bankss role is limited and the do not guarantee payment Banks do not verify the accuracy of the document

Documentary Collection Scheme

2 Exporter (China) 9 1 Custom /Legal Institution 1 Importer (USA) 5

Remitting (Exporter) Bank

Collecting (Importer) Bank

Explanation :
Exporter sends goods to custom and presents the document with instruction for obtaining payment to the exporter bank. Importer give the document of purchasing Exporter tell the remitting bank to send the document to the collecting bank. The remitting bank sends the document to the collecting bank Collecting bank releases the document to the importer, receipt of payment or a acceptance of the drafts. This documents uses to obtain the goods & to clear them at the customs. Importer pay the money to the collecting bank (debited account) After receives the payment, collecting bank forward the proceeds to the remitting bank The remitting bank then credits the exporters account.

2d. Open Account

A sale where a goods are shipped and delivered before payment is due, which is usually in 30 to 90 days. Applicable for a low-risk trading relationships/markets and in competitive markets to win customers with the use of one or more appropriate trade finance techniques. Advantages : Boost competitiveness in the global market Helps establish and maintain a succesful trade relationships Disadvantages : Significant exposure to the risk of non-payment Additional costs associated with risk mitigation measures.

How to offer Open Account Terms in Competitive Markets?

By using several techniques : a. Export working capital financing b. Government-guaranteed export working capital programs c. Export credit insurance d. Export factoring

a. Export Working Capital Financing

EWC financing allows exporter to purchase the goods and services they need to support their export sales. EWC facilitates the Small-Medium Enterprises (SME) who lack sufficient internal liquidity to process and acquire goods and services to fulfill export orders and to extend open account terms to their foreign buyer. Advantages : Allows fulfillment of export sales orders Allows exporter to offer open account terms to remain competitive Disadvantages : Generally available only to SMEs with access to strong personal guarantees, assets or high value receivables Additional costs associated with risk mitigation measures.

b. Government-Guaranteed Export Working Capital Loan Programs

Early stage of SME are usually not eligible for commercial financing without government guarantee and it also generally reluctant to extend credit due to the repayment risk associated with export sales. So, government should provide EWC loans to help the exporters liquidity.

Advantages : Encourages lenders to offer financing to exporters Enables lenders to offer generous advance rates

Disadvantages : Cost of obtaining and maintaining a guaranteed facility Additional costs associated with risk mitigation measures

c. Export Credit Insurance

Export Credit Insurance (ECI) protects an exporter of products and services against the risk of non-payment by a foreign buyer. It reduces the payment risk associated by giving a conditional assurance that payment will be made if the foreign buyer is unable to pay. ECI generally covers commercial risks (insolvency of the buyer, bankruptcy, protracted defaults, slow payment, political risk, currency inconvertibility expropriation and regulation changes. Advantages : Reduce the risk of nonpayment by foreign buyers Offer open account terms safely in the global market Disadvantages : Cost of obtaining and maintaining an insurance policy Risk sharing in the form of deductible

d. Export Factoring
Complete financial package that combines EWC financing, credit protection, foreign accounts receivable bookkeeping and collection services. This bank or special financial firm offered under an agreement between the factor and exporter in which the factor purchases the exporter s short term foreign accounts receivable for cash at a discount from the face value, without recourse. Advantages : Eliminating risk of non-payment by foreign buyers Handles collections on the receivables, Improves liquidity position and cash flow. Disadvantages : More costly than export credit insurance Generally not available in developing countries

China Balance of Trade

Why RMB had no exposure in those graphs?

Chinese RenMinBi (RMB) had little to no exposure in the international markets because of : 1. Strict government controls by the central Chinese government prohibited almost all export of the currency, or use of it in international transactions. 2. Chinese companies unable to hold US dollars and foreign companies unable to hold Chinese yuan. 3. Transactions between Chinese companies and a foreign entity were generally denominated in US dollars. 4. All transactions would go through the People's Bank of China. 5. The central bank would pass the settlement in renminbi to the Chinese company at the state-controlled exchange rate.

Fact about RMB in International Trade Financing

The World Bank estimated that, by purchasing power parity, one International Dollar was equivalent to approximately RMB1.9 in 2004. Yuan is undervalued by 37,5% on the basis of purchasing power parity analysis. The International Monetary Fund estimated that, by purchasing power parity, one United States dollar was equivalent to approximately RMB 3.462 in 2006, RMB 3.621 in 2007, RMB 3.798 in 2008, RMB 3.872 in 2009, and RMB3.922 in 2010.

RMB vs US$ (2007-2011)

d

Countertrade
Countertrade consists of transactions which have as a basic characteristic a linkage, legal or otherwise, between exports and imports of goods or services in addition to, or in place of, financial settlements. Countertrade can be used as an effective international business tool. Countertrade plays a part in 20-25 percent of world trade that carried out wholly or partially in goods rather than money.
Sources : http://www.witiger.com/internationalbusiness/countertrade.htm

Why Countertrade ?
1. The world debt crisis has made ordinary trade financing very risky. (Large banks and financial institutions are "risk adverse" in many of the hostile regions of the world opening to trade). 2. Many countries cannot obtain the trade credit or financial assistance to pay for desired imports. (The IMF and World Bank are increasingly restrictive in the way they allow governments to operate). 3. Countries are increasingly returning to the notion of bilateralism as a way to reduce trade imbalances. 4. Countertrade is often viewed as an excellent mechanism to gain entry into new markets. The party receiving the goods may become a new distributor, opening up new international marketing channels and ultimately expanding the market. 5. Providing countertrade services helps sellers differentiate its products from those of competitors. (Flexibility is key to winning business in a global market that is more and more competitive to vendors)

Sources : Fisher College of Business, Ohio State University

Forms of Countertrade
Barter- direct exchange of goods or services having equivalent values without a cash transaction Counterpurchase: involves 2 simultaneous separate transactions between 2 parties with or without cash Buyback or compensation: involves repayment in the form of goods derived from directly from, or produced by, the technology, plant, or equipment provided by the seller Offsets: involves an arrangement whereby the seller is required to assist in or to arrange for the marketing of products produced by the buying country or to allow some portion of the exported product to be assembled or manufactured by producers located in the buying country. Switch-trading: refers to a switch in the country of destination goods

Adv & Disadv of Countertrade

Advantages :
Disadvantages :

Countertrade conserves cash and It is inefficient. hard currency. Some claim that such The improvement of trade transactions tamper with the imbalances, the maintenance of fundamental operation of free export prices, enhanced economic markets, and therefore development, increased resources will be used employment, technology transfer, inefficiently. market expansion, increased profitability, less costly sourcing of Transactions that do not make use of money represent a huge supply reduction of surplus goods step backwards in economic from inventory, and the development. development of marketing expertise.

Forfaiting
A method of trade financing that allows exporter to obtain cash by selling their medium-term foreign accounts receivable at a discount on a without recourse basis.

A forfaiter is a specialized finance firm or a department in a bank that performs non-recourse export financing trough the purchase of medium term trade receivables. It eliminates the risk of non-payment once the goods have been delivered to the foreign buyer in accordance with the terms of sale.

Applicable for exports of capital goods, commodities, and large projects on medium term credit (180 days to 7 years) Risk inherent in an export sale is virtually eliminated. Receivables are normally guaranteed by the importers bank which allows the exporter to take the transaction off the balance sheet to enhance financial ratios. The current minimum transaction size for forfaiting is $ 100,000 Advantages : Eliminates the risk of nonpayment by foreign buyers. Offers strong capabilities in emerging and developing markets. Disadvantages : Cost is often higher than commercial lender financing Limited to medium-term transactions and those exceeding $100.000

Cost of Forfaiting : the cost is determined by the rate of discount based on the aggregate of the LIBOR (London Inter Bank Offered Rate) for the tenor of the receivables and a margin reflecting the risk being sold. The degree of risk varies based on the importing country, the length of loan, the currency of transaction and the repayment structure. (the higher the risk, the higher the margin and the higher the discount rate)
Three additional major advantages of forfaiting : a. Volume : forfaiting can work on a one-shot deal, without requiring an ongoing volume of business b. Speed : commitments can be issued within hours or days depending on details and country c. Simplicity : documentation is usually simpel, concise and straightforward.

Benefits of Forfaiting
Eliminates Risk * Removes political, transfer and commercial risk * Provides financing for 100% of contract value * Protects against risks of interest rate increase and exchange rate fluctuation Enhances Competitive Advantage * Enables sellers of goods to offer credit to their customers, making their products more attractive * Helps sellers to do business in countries where the risk of non-payment would otherwise be too high

Benefits of Forfaiting (cont)

Improves Cash Flow * Forfaiting enables sellers to receive cash payment while offering credit terms to their customers * Removes accounts receivable, bank loans or contingent liabilities from the balance sheet Increases Speed and Simplicity of Transactions * Fast, tailor-made financing solutions * Financing commitments can be issued quickly * Documentation is typically concise and straightforward * No restrictions on origin of export * Relieves seller of administration and collection burden

Government Assistance in Exporting

Government-assisted by export-import bank helps to turn export opportunities, especially in high-risk emerging markets, into real transactions for large corporations and established medium-sized companies. This type of financing provides direct loans to foreign buyers at fixed rate or provides guarantees for term financing offered by commercial lenders. Financing is available for medium term (up to 5 years) and long term (up to 10 years) transaction. It is applicable for the export of high-value capital goods or services or large-scale projects that require extended-term financing

The Export-Import Banks

Ex-Im Bank provides direct loan or by guaranteeing commercial loans to creditworthy foreign buyers for purchases domestic goods and services. Key features of Ex-Im Banks : 1. Loans are made by commercial banks and guaranteed by Ex-Im Bank. 2. Loans cover 100 percent principal and interest for 85% of the contract price. 3. Interest rate are negotiable, floating and lower than fixed rates. 4. Loans are fully transferable, securitized and available in certain foreign currencies. 5. Loans have a faster documentation process with the assistance of commercial banks.

To improve our knowledge of International Trade Financing, lets answer these :

Problem 1 :
1. Assume the time from acceptance to maturity on a $ 2,000,000 bankers acceptance is 90 days. Further assume that the importing banks acceptance commission is 1.25 percent and that the market rate for 90-day B/A is 7 percent. Determine the amount the exporter will receive if he holds the B/A until maturity and also the amount the exporter will receive if he discounts the B/A with the importers bank.

Problem 2 :
2. The time from acceptance to maturity on a $1,000,000 bankers acceptance is 120 days. The importers bank acceptance commission is 1.75 percent and the market rate for 120-days B/A is 5.75 percent. What amount will the exporter receive if he holds the B/A until maturity? If he discount the B/A with the importers bank? Also determine the bond equivalent yield the importer bank will earn from discounting the B/A with the exporter. If the exporters opportunity cost of capital is 11 percent, should he discount the B/a or hold it to maturity?

Conclusion
Conducting international trade transactions and trade financing is difficult in comparison to domestic trades. Commercial and political risk enter into the equation so it is Important for a country to be competitively strong in international trade. A typical foreign trade transaction requires three basic documents: letter of credit, time draft, and bill of lading. Forfaiting in which a bank purchase at a discount from an importer a series of promissory notes in favor of an exporter is a medium-term form of trade financing The export-import bank provide competitive assistance to exporters through direct loans to foreign importers, loan guarantees and credit insurance to the exporters. Countertrade transaction are gaining renewed prominence as a means of conducting international trade transactions.

Indonesia Importer

This is the end of Chapter 20,

Any Questions?

Thanks for your Attention!