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Notes Session 11 - Notes Session 11 > Chapter 19 Financing...

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Notes - Session 11 >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Chapter 19: Financing International Trade Chapter 20: Short-Term Financing >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Financing International Trade The five basic methods of international payment are prepayment, letters of credit, drafts, consignment and open account. Domestic transactions also frequently use prepayment (which shifts the risk to the buyer, open account whereby a bill is sent to the customer after the goods are shipped and consignment where title remains with the seller and unsold goods are returned from the consignee. While international transactions between known parties may very well use prepayment, open account or consignment, none of these methods solves the problem of trust, which is the single largest problem in international payments and receipts. Letters of credit and drafts have developed as methods of financing international trade in response to the lack of trust that exists when it is necessary for buyers and sellers to transact business when they have never met and live in different countries. The exporter wishes to get payment before shipping goods; the importer wants to get the goods before making payments. The problem of trust is compounded in an international setting by the difficulty of pursuing legal cases internationally. Hence the popularity of drafts and letters of credit for making international payments. Letters of credit and drafts are instruments designed to reduce risk. In a letter of credit, the bank acts as an intermediary and substitutes its credit for that of the borrower. At the request of an importer, the bank issues a Letter of credit promising that the bank will pay a specified sum of money to the exporter on presentation of shipping documents. (The bank collects between 0.5 and 2 percent of the value of the letter of credit). The letter of credit becomes a financial contract between the bank and the U.S. exporter, obligating the bank to pay even if the importer fails to repay the bank. The importer does not have to pay out funds for the merchandise until the documents have arrived and unless all conditions stated in the letter of credit have been satisfied. Once the U.S. exporter sees the letter of credit, he knows he is guaranteed payment and will ship the merchandise.
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A draft or Bill of Exchange is most commonly used in international transactions. A draft is an
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