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

Checks

Foreign Exchange

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 JPY = .0129769 USD

Direct Quote (American)

1

Who uses Foreign Exchange

Tourists Importers / Exporters Investors Speculators Central Banks

Which Currencies are Traded

Local Currency Payment

Western

US$ Payment
South

Europe Japan, Hong Kong, Singapore, Australia and New Zealand Canada, Mexico South Africa Thailand, Indonesia

America Eastern Europe China, Taiwan Africa Malaysia

Instruments most commonly used to offset risk

Spot Forwards (up to 1 year typically) Futures Swaps Options

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

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)

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 currencys interest rate is higher currency is at a DISCOUNT against another currency in the forward market when that other currencys interest rate is lower

Options

The right but not the obligation to convert one currency for another on a specific future date. Price is based on:
current spot strike price

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.

Options vs Forward Contract

Forward Contract
Eliminates

Option
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

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

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

Futures versus Forwards

Advantages
Smaller

Disadvantages
Limited

size Freedom to liquidate a contract anytime

number of currencies Limited delivery dates Rigid contractual amounts

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

Payment Methods

International Payment Methods

Cash in Advance Open Account Documentary Collections Letters of Credit

Risk vs. Method of Payment

Buyer Risk Open Account Documentary Collection Low Letter of Credit Cash in Advance High Seller Risk High

Low

Cash In Advance

Time of Payment

Before Shipment
After Payment None Seller has negotiating strength to demand cash in advance

Goods Available to Buyer

Risks to Seller

When Appropriate

Open Account

Time of Payment
As

agreed; i.e. 30 days

Goods Available to Buyer

Before
Buyer

Payment

Risks to Seller
defaults on payment obligation Delays in availability of foreign exchange and transferring of funds from buyers country

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

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

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

Documentary Collection
Seller Buyer

Documents

Documents

Documents

$
Sellers Bank Buyers Bank

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 ________________________________________ _________________________________________ _________________________________________ DRAWEE ______________________________________ DRAWER ______________________________________ BY: AUTHORIZED SIGNATURE

Documentary Collection - D/P

Time of Payment
On

presentation of sight draft by a bank to buyer

payment

Goods Available to Buyer

After

Risks to Seller
Buyers

nonacceptance of shipment Payment delays due to unavailability of foreign exchange in buyers country Payment blocked due to political actions in buyers country

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

Documentary Collections - D/A

Time of Payment
At

maturity of accepted draft

payment

Goods Available to Buyer

Before

Risks to Seller
Buyers

default on payment obligation Delays in availability of foreign exchange and transferring of funds from buyers country Payment blocked due to political events in buyers country

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

Documentary Collections Risk

Unscrupulous buyer Insolvent buyer Buyer changes mind Buyers country is in turmoil Foreign exchange may not be available Seller may have to pay return freight Buyer may not honor promise to pay

Letter of Credit

Letters of Credit (L/Cs) are legal instruments issued 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

Letter of Credit Key Parties

Applicant
Buyer/Importer

Advising Bank
authenticates

LC

Beneficiary
Seller/Exporter

Confirming Bank
guarantees

Issuing Bank
Guarantees

payment if Issuing Bank defaults

payment

L/C Terminology
Irrevocable ICC

UCP

Tenor
Sight Usance

600 ISP 98

Discrepancies

Incoterms

Uniform Customs and Practices for Documentary Credits

The 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.

Commonly Used Documents

Commercial Invoice Transport Document

Ocean Bill of Air Waybill

Lading

Packing Lists/Weight Lists Insurance Policy or Certificate Draft or Bill of Exchange Other Documents
Inspection Certificate Special Customs Invoices Certificate of Origin

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

Letter of Credit Issuance

Exporter

Contract Step 1

Importer Application Made Step 2 for Letter of Credit

Step 4

L/C Forwarded to Beneficiary with or without confirmation

Advising Bank in Exporters City

Letter of Credit Forwarded by the Issuing Bank Step 3

Issuing Bank in Importers City

Letter of Credit Payment

Step 3 Issuing / Opening Bank
Money Documents Money
Money

Step 4
Documents

Advising/ Confirming Bank

Step 2

Documents

Step 5
Surrenders Bill of Lading

Buyer Importer Account Party

Receives Goods

Seller/ Exporter Beneficiary

Receives Bill of Lading

Step 1

Surrenders Goods

Carrier

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

Letter of Credit

Risks to Seller
Discrepancies

in the documents Buyers Bank (opening bank) defaults on its payment obligation Payment blocked due to political events in buyers country

When Appropriate
Seller

is unsure of creditworthiness of buyer

Letter of Credit Variations

Back to Back Assignment of Proceeds Transferable Revolving Standby

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.

Standby Letter of Credit

Financial
Assures account partys performance of a financial obligation, i.e., to pay an invoice by a certain date.

Performance
Assures account partys performance of a nonfinancial contract obligation, i.e., to deliver products under a contract.

Factors to Consider in Determining Payment Terms Under a Contract

Question What is customer relationship Impact of total loss ($) Nature of order Political situation buyers country Economic situation buyers country Competition to sell goods Changing price environment Experience in preparing documents Company policy for protection Letter of Credit New Substantial Custom Collection Established Normal Normal Production Stable Open Account Parent/Sub Small Excess Inventory

Unstable

Strong

Unstable

Stable

Strong

No Yes Extensive

Some No Some

Heavy No None

Strong

Medium

Unwritten

Other Financing Options

Countertrade
i.e.

barter, counterpurchase, compensation sale of short term receivables

Factoring
Outright

Forfaiting
Outright

sale of medium term (large) obligation

International Trade Payment Methods

Cassie Stiles cassstiles@yahoo.com