FINANCING FOREIGN TRADE
This chapter is primarily factual, describing the various institutions and details involved in financing foreign trade. The
most important documents encountered in bank-related financing are the
, which is a written order to pay; the
, which is a bank guarantee of payment provided that certain stipulated conditions are met; and the
, the document covering title and actual shipment of the merchandise by a common carrier. Other documents of
lesser importance include the
The functions of these instruments, and hence the rationale for their existence, are:
To reduce both buyer and seller risk.
To pinpoint who bears those risks that remain.
To facilitate the transfer of risk to a third party.
To facilitate financing.
Each instrument evolved over time as a rational response to the additional risks in international trade posed by
greater distances, the lack of familiarity between exporters and importers, the possibility of government imposition
of exchange controls, and greater costs involved in bringing suit against a party domiciled in another nation.
The existence of government programs that provide subsidized export financing, such as the U.S. Eximbank,
creates a market imperfection that MNCs can exploit to lower their risk-adjusted cost of funds.
Countertrade has evolved in response to government efforts to control the allocation of foreign exchange. Although
an inefficient means of conducting trade, it exists and should be understood.
SUGGESTED ANSWERS TO CHAPTER 18 QUESTIONS
What are the basic problems arising in international trade financing and how do the main financing instruments
help solve those problems?
The main problems arising in international trade financing are the risks that both buyer and seller bear in
cross border trade, how to allocate those risks in a way that ensures that those best able to bear them or are in the best
position to mitigate them do so, to facilitate the transfer of remaining risks to a third party, and to attain financing at
as low a cost as possible. The principal financing instruments and mechanisms examined here are the letter of credit,
banker's acceptance, factoring, forfaiting, and government export financing and credit guarantees.
Letter of credit.
The L/C eliminates credit risk to the exporter if the bank that opens it is of undoubted standing and it
also reduces the danger that payment will be delayed or withheld owing to exchange controls or other political acts.
Other risks that the L/C guards against are explained in the chapter. The L/C also facilitates financing because it ensures
the exporter a ready buyer for its product. It also becomes especially easy to create a banker's acceptance. From the
importer's standpoint, since payment is only in compliance with the L/C's stipulated conditions, the importer is able
to ascertain that the merchandise is actually shipped on, or before, a certain date by requiring an on-board bill of lading.