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Unformatted text preview: Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 CHAPTER 19 Financing International
he international trade activities of MNCs have T ordered. Fourth, even if the exporter does ship the goods, grown in importance over time. This trend is attrib- trade barriers or time lags in international transportation utable to the increased globalization of the world might delay arrival time. Financial managers must recognize economies and the availability of trade ﬁnance from the in- methods that they can use to ﬁnance international trade so ternational banking community. Although banks also that they can conduct exporting or importing in a manner ﬁnance domestic trade, their role in ﬁnancing international that maximizes the value of an MNC. trade is more critical due to the additional complications
involved. First, the exporter might question the importer’s The speciﬁc objectives of this chapter are to:
■ describe methods of payment for international trade, ability to make payment. Second, even if the importer is ■ explain common trade ﬁnance methods, and creditworthy, the government might impose exchange ■ describe the major agencies that facilitate international
trade with export insurance and/or loan programs. controls that prevent payment to the exporter. Third, the
importer might not trust the exporter to ship the goods Payment Methods for International Trade
In any international trade transaction, credit is provided by either the supplier (exporter), the buyer (importer), one or more ﬁnancial institutions, or any combination of
these. The supplier may have sufﬁcient cash ﬂow to ﬁnance the entire trade cycle, beginning with the production of the product until payment is eventually made by the
buyer. This form of credit is known as supplier credit. In some cases, the exporter may
require bank ﬁnancing to augment its cash ﬂow. On the other hand, the supplier may
not desire to provide ﬁnancing, in which case the buyer will have to ﬁnance the transaction itself, either internally or externally, through its bank. Banks on both sides of the
transaction can thus play an integral role in trade ﬁnancing.
562 C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 563 Exhibit 19.1 Comparison of Payment Methods
Method Usual Time of
Payment Goods Available
to Buyers Risk to Exporter Risk to Importer Before shipment After payment None Relies completely on
exporter to ship
goods as ordered Letter of credit Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 Prepayment When shipment
is made After payment Very little or none,
credit terms Assured shipment
made, but relies on
exporter to ship goods
described in documents Sight draft;
against payment On presentation
of draft to buyer After payment If draft unpaid,
must dispose of goods Same as above unless
importer can inspect
goods before payment Time draft;
acceptance On maturity of drafts Before payment Relies on buyer
to pay drafts Same as above Consignment At time of sale
by buyer Before payment Allows importer to
sell inventory before
paying exporter None; improves
cash ﬂow of buyer Open account As agreed Before payment Relies completely on
buyer to pay account
as agreed None In general, ﬁve basic methods of payment are used to settle international transactions, each with a different degree of risk to the exporter and importer (Exhibit 19.1):
Letters of credit
Drafts (sight /time)
Open account Prepayment
Under the prepayment method, the exporter will not ship the goods until the buyer has
remitted payment to the exporter. Payment is usually made in the form of an international wire transfer to the exporter’s bank account or foreign bank draft. As technology
progresses, electronic commerce will allow ﬁrms engaged in international trade to make
electronic credits and debits through an intermediary bank. This method affords the
supplier the greatest degree of protection, and it is normally requested of ﬁrst-time buyers whose creditworthiness is unknown or whose countries are in ﬁnancial difﬁculty.
Most buyers, however, are not willing to bear all the risk by prepaying an order. Letters of Credit (L /C)
A letter of credit (L /C) is an instrument issued by a bank on behalf of the importer (buyer)
promising to pay the exporter (beneﬁciary) upon presentation of shipping documents
in compliance with the terms stipulated therein. In effect, the bank is substituting its 564 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 http://
Many banks have a
website that explains
the variety of trade
ﬁnancing that they
can provide for ﬁrms.
See, for example,
HNB2740.htm. credit for that of the buyer. This method is a compromise between seller and buyer because it affords certain advantages to both parties. The exporter is assured of receiving
payment from the issuing bank as long as it presents documents in accordance with the
L /C. An important feature of an L /C is that the issuing bank is obligated to honor drawings under the L /C regardless of the buyer’s ability or willingness to pay. On the other
hand, the importer does not have to pay for the goods until shipment has been made and
the documents are presented in good order. However, the importer must still rely upon
the exporter to ship the goods as described in the documents, since the L /C does not
guarantee that the goods purchased will be those invoiced and shipped. Letters of credit
will be described in greater detail later in this chapter. Drafts
A draft (or bill of exchange) is an unconditional promise drawn by one party, usually the
exporter, instructing the buyer to pay the face amount of the draft upon presentation.
The draft represents the exporter’s formal demand for payment from the buyer. A draft
affords the exporter less protection than an L /C, because the banks are not obligated to
honor payments on the buyer’s behalf.
Most trade transactions handled on a draft basis are processed through banking
channels. In banking terminology, these transactions are known as documentary collections. In a documentary collection transaction, banks on both ends act as intermediaries
in the processing of shipping documents and the collection of payment. If shipment is
made under a sight draft, the exporter is paid once shipment has been made and the
draft is presented to the buyer for payment. The buyer’s bank will not release the shipping documents to the buyer until the buyer has paid the draft. This is known as documents against payment. It provides the exporter with some protection, since the banks
will release the shipping documents only according to the exporter’s instructions. The
buyer needs the shipping documents to pick up the merchandise. The buyer does not
have to pay for the merchandise until the draft has been presented.
If a shipment is made under a time draft, the exporter instructs the buyer’s bank to
release the shipping documents against acceptance (signing) of the draft. This method
of payment is sometimes referred to as documents against acceptance. By accepting the
draft, the buyer is promising to pay the exporter at the speciﬁed future date. This accepted draft is also known as a trade acceptance, which is different from a banker’s acceptance (disussed later in the chapter). In this type of transaction, the buyer is able to
obtain the merchandise prior to paying for it.
The exporter is providing the ﬁnancing and is dependent upon the buyer’s ﬁnancial
integrity to pay the draft at maturity. Shipping on a time draft basis provides some added
comfort in that banks at both ends are used as collection agents. In addition, a draft
serves as a binding ﬁnancial obligation in case the exporter wishes to pursue litigation
on uncollected receivables. The added risk is that if the buyer fails to pay the draft at maturity, the bank is not obligated to honor payment. The exporter is assuming all the risk
and must analyze the buyer accordingly. Consignment
Under a consignment arrangement, the exporter ships the goods to the importer while
still retaining actual title to the merchandise. The importer has access to the inventory
but does not have to pay for the goods until they have been sold to a third party. The ex- C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 565 Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 porter is trusting the importer to remit payment for the goods sold at that time. If the
importer fails to pay, the exporter has limited recourse because no draft is involved and
the goods have already been sold. As a result of the high risk, consignments are seldom
used except by afﬁliated and subsidiary companies trading with the parent company.
Some equipment suppliers allow importers to hold some equipment on the sales ﬂoor
as demonstrator models. Once the models are sold or after a speciﬁed period, payment
is sent to the supplier. Open Account
The opposite of prepayment is the open account transaction in which the exporter ships
the merchandise and expects the buyer to remit payment according to the agreed-upon
terms. The exporter is relying fully upon the ﬁnancial creditworthiness, integrity, and
reputation of the buyer. As might be expected, this method is used when the seller and
buyer have mutual trust and a great deal of experience with each other. Despite the risks,
open account transactions are widely utilized, particularly among the industrialized
countries in North America and Europe. Trade Finance Methods
As mentioned in the previous section, banks on both sides of the transaction play a critical role in ﬁnancing international trade. The following are some of the more popular
methods of ﬁnancing international trade:
■ Accounts receivable ﬁnancing
Letters of credit (L /Cs)
Working capital ﬁnancing
Medium-term capital goods ﬁnancing (forfaiting)
Countertrade Each of these methods is described in turn. Accounts Receivable Financing
The Bankers’ Association for Finance and
Trade has a website
jsps/ that provides
about bankers’ acceptances and the
ﬁnancing of foreign
trade. In some cases, the exporter of goods may be willing to ship goods to the importer without an assurance of payment from a bank. This could take the form of an open account
shipment or a time draft. Prior to shipment, the exporter should have conducted its own
credit check on the importer to determine creditworthiness. If the exporter is willing to
wait for payment, it will extend credit to the buyer.
If the exporter needs funds immediately, it may require ﬁnancing from a bank. In
what is referred to as accounts receivable ﬁnancing, the bank will provide a loan to the
exporter secured by an assignment of the account receivable. The bank’s loan is made to
the exporter based on its creditworthiness. In the event the buyer fails to pay the exporter for whatever reason, the exporter is still responsible for repaying the bank.
Accounts receivable ﬁnancing involves additional risks, such as government restrictions and exchange controls, that may prevent the buyer from paying the exporter. As a 566 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T result, the loan rate is often higher than domestic accounts receivable ﬁnancing. The
length of a ﬁnancing term is usually one to six months. To mitigate the additional risk
of a foreign receivable, exporters and banks often require export credit insurance before
ﬁnancing foreign receivables. Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 Factoring
When an exporter ships goods before receiving payment, the accounts receivable balance increases. Unless the exporter has received a loan from a bank, it is initially ﬁnancing the transaction and must monitor the collections of receivables. Since there is a
danger that the buyer will never pay at all, the exporting ﬁrm may consider selling the
accounts receivable to a third party, known as a factor. In this type of ﬁnancing, the exporter sells the accounts receivable without recourse. The factor then assumes all administrative responsibilities involved in collecting from the buyer and the associated
credit exposure. The factor performs its own credit approval process on the foreign
buyer before purchasing the receivable. For providing this service, the factor usually
purchases the receivable at a discount and also receives a ﬂat processing fee.
Factoring provides several beneﬁts to the exporter. First, by selling the accounts receivable, the exporter does not have to worry about the administrative duties involved
in maintaining and monitoring an accounts receivable accounting ledger. Second, the
factor assumes the credit exposure to the buyer, so the exporter does not have to maintain personnel to assess the creditworthiness of foreign buyers. Finally, by selling the
receivable to the factor, the exporter receives immediate payment and improves its
Since it is the importer who must be creditworthy from a factor’s point of view, crossborder factoring is often used. This involves a network of factors in various countries who
assess credit risk. The exporter’s factor contacts a correspondent factor in the buyer’s
country to assess the importer’s creditworthiness and handle the collection of the receivable. Factoring services are usually provided by the factoring subsidiaries of commercial banks, commercial ﬁnance companies, and other specialized ﬁnance houses.
Factors often utilize export credit insurance to mitigate the additional risk of a foreign
receivable. Letters of Credit (L /C)
Introduced earlier, the letter of credit (L /C) is one of the oldest forms of trade ﬁnance
still in existence. Because of the protection and beneﬁts it accords to both exporter and
importer, it is a critical component of many international trade transactions. The L /C is
an undertaking by a bank to make payments on behalf of a speciﬁed party to a
beneﬁciary under speciﬁed conditions. The beneﬁciary (exporter) is paid upon presentation of the required documents in compliance with the terms of the L /C. The L /C
process normally involves two banks, the exporter’s bank and the importer’s bank. The
issuing bank is substituting its credit for that of the importer. It has essentially guaranteed payment to the exporter, provided the exporter complies with the terms and conditions of the L /C.
Sometimes the exporter is uncomfortable with the issuing bank’s promise to pay because the bank is located in a foreign country. Even if the issuing bank is well known
worldwide, the exporter may be concerned that the foreign government will impose exchange controls or other restrictions that would prevent payment by the issuing bank. C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 567 For this reason, the exporter may request that a local bank conﬁrm the L /C and thus
assure that all the responsibilities of the issuing bank will be met. The conﬁrming bank
is obligated to honor drawings made by the beneﬁciary in compliance with the L /C
regardless of the issuing bank’s ability to make that payment. Consequently, the conﬁrming bank is trusting that the foreign bank issuing the L /C is sound. The exporter,
however, need worry only about the credibility of the conﬁrming bank. Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 EXAMPLE Nike can attribute part of its international business growth in the 1970s to the use of
L /Cs. In 1971, Nike (which was then called BSR) was not well known to businesses in
Japan or anywhere else. Nevertheless, by using L /Cs, it was still able to subcontract the
production of athletic shoes in Japan. The L /Cs assured the Japanese shoe producer
that it would receive payment for the shoes it would send to the United States and thus
facilitated the ﬂow of trade without concern about credit risk. Banks served as the
guarantors in the event that the Japanese shoe company was not paid in full after transporting shoes to the United States. Thus, because of the backing of the banks, the L /Cs
allowed the Japanese shoe company to do international business without having to
worry that the counterparty in its agreement would not fulﬁll its obligation. Without
such agreements, Nike (and many other ﬁrms) would not be able to order shipments of
Types of Letters of Credit. Trade-related letters of credit are known as commercial letters of credit or import/export letters of credit. There are basically two types: revocable
and irrevocable. A revocable letter of credit can be canceled or revoked at any time without prior notiﬁcation to the beneﬁciary, and it is seldom used. An irrevocable letter of
credit (see Exhibit 19.2) cannot be canceled or amended without the beneﬁciary’s
consent. The bank issuing the L /C is known as the “issuing” bank. The correspondent
bank in the beneﬁciary’s country to which the issuing bank sends the L /C is commonly
referred to as the “advising” bank. An irrevocable L /C obligates the issuing bank to
honor all drawings presented in conformity with the terms of the L /C. Letters of credit
are normally issued in accordance with the provisions contained in “Uniform Customs Exhibit 19.2 Name of issuing bank Example of an Irrevocable
Letter of Credit Address of issuing bank
Name of exporter
Address of exporter We establish our irrevocable letter of credit:
for the account of (importer name),
in the amount of (value of exports),
available by your draft at (time period) days sight and accompanied by: (any invoices,
packing lists, bills of lading, etc., that need to be presented with the letter of credit)
Insurance provided by (exporter or importer)
covering shipment of (merchandise description)
From: (port of shipment)
To: (port of arrival) (Authorized Signature) Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 568 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T and Practice for Documentary Credits,” published by the International Chamber of
The bank issuing the L /C makes payment once the required documentation has
been presented in accordance with the payment terms. The importer must pay the issuing bank the amount of the L /C plus accrued fees associated with obtaining the L /C.
The importer usually has established an account at the issuing bank to be drawn upon
for payment, so that the issuing bank does not tie up its own funds. However, if the importer does not have sufﬁcient funds in its account, the issuing bank is still obligated to
honor all valid drawings against the L /C. This is why the bank’s decision to issue an L /C
on behalf of an importer involves an analysis of the importer’s creditworthiness and is
analogous to the decision to make a loan. The documentary credit procedure is depicted
in the ﬂowchart in Exhibit 19.3. In what is commonly referred to as a reﬁnancing of a
sight L /C, the bank arranges to fund a loan to pay out the L /C instead of charging the
importer’s account immediately. The importer is responsible for repaying the bank both
the principal and interest at maturity. This is just another method of providing extended
payment terms to a buyer when the exporter insists upon payment at sight.
The bank issuing the L /C makes payment to the beneﬁciary (exporter) upon presentation of documents that meet the conditions stipulated in the L /C. Letters of credit
are payable either at sight (upon presentation of documents) or at a speciﬁed future date.
The typical documentation required under an L /C includes a draft (sight or time), a
commercial invoice, and a bill of lading. Depending upon the agreement, product, or
country, other documents (such as a certiﬁcate of origin, inspection certiﬁcate, packing
list, or insurance certiﬁcate) might be required. The three most common L /C documents are as follows.
Draft. Also known as a bill of exchange, a draft (introduced earlier) is an unconditional
promise drawn by one party, usually the exporter, requesting the importer to pay the
face amount of the draft at sight or at a speciﬁed future date. If the draft is drawn at sight, Exhibit 19.3 Documentary Credit Procedure
(1) Contract of Sale
(5) Delivery of Goods (2)
Delivered (7) Documents Presented to Issuing Bank
(Issuing Bank) (9) Payment
(3) Credit Sent to Correspondent Correspondent
Bank C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 569 it is payable upon presentation of documents. If it is payable at a speciﬁed future date (a
time draft) and is accepted by the importer, it is known as a trade acceptance. A banker’s
acceptance is a time draft drawn on and accepted by a bank. When presented under an
L /C, the draft represents the exporter’s formal demand for payment. The time period,
or tenor, of most time drafts is usually anywhere from 30 to 180 days. Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 Bill of Lading. The key document in an international shipment under an L /C is the bill
of lading (B/L). It serves as a receipt for shipment and a summary of freight charges; most
importantly, it conveys title to the merchandise. If the merchandise is to be shipped by
boat, the carrier will issue what is known as an ocean bill of lading. When the merchandise is shipped by air, the carrier will issue an airway bill. The carrier presents the bill to
the exporter (shipper), who in turn presents it to the bank along with the other required
A signiﬁcant feature of a B/L is its negotiability. A straight B/L is consigned directly
to the importer. Since it does not represent title to the merchandise, the importer does
not need it to pick up the merchandise. When a B/L is made out to order, however, it
is said to be in negotiable form. The exporter normally endorses the B/L to the bank
once payment is received from the bank.
The bank will not endorse the B/L over to the importer until payment has been
made. The importer needs the original B/L to pick up the merchandise. With a negotiable B/L, title passes to the holder of the endorsed B/L. Because a negotiable B/L grants
title to the holder, banks can take the merchandise as collateral. A B/L usually includes
the following provisions:
■ A description of the merchandise
Identiﬁcation marks on the merchandise
Evidence of loading (receiving) ports
Name of the exporter (shipper)
Name of the importer
Status of freight charges (prepaid or collect)
Date of shipment Commercial Invoice. The exporter’s (seller’s) description of the merchandise being
sold to the buyer is the commercial invoice, which normally contains the following
■ Name and address of seller
Name and address of buyer
Terms of payment
Price, including freight, handling, and insurance if applicable
Quantity, weight, packaging, etc.
Shipping information Under an L /C shipment, the description of the merchandise outlined in the invoice
must correspond exactly to that contained in the L /C.
Variations of the L /C. There are several variations of the L /C that are useful in ﬁnancing trade. A standby letter of credit can be used to guarantee invoice payments to a
supplier. It promises to pay the beneﬁciary if the buyer fails to pay as agreed. Internationally, standby L /Cs often are used with government-related contracts and serve as Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 570 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T bid bonds, performance bonds, or advance payment guarantees. In an international or
domestic trade transaction, the seller will agree to ship to the buyer on standard open
account terms as long as the buyer provides a standby L /C for a speciﬁed amount and
term. As long as the buyer pays the seller as agreed, the standby L /C is never funded.
However, if the buyer fails to pay, the exporter may present documents under the L /C
and request payment from the bank. The buyer’s bank is essentially guaranteeing that
the buyer will make payment to the seller.
A transferable letter of credit is a variation of the standard commercial L /C that allows the ﬁrst beneﬁciary to transfer all or a part of the original L /C to a third party. The
new beneﬁciary has the same rights and protection as the original beneﬁciary. This type
of L /C is used extensively by brokers, who are not the actual suppliers. EXAMPLE The broker asks the foreign buyer to issue an L /C for $100,000 in his favor. The L /C
must contain a clause stating that the L /C is transferable. The broker has located an end
supplier who will provide the product for $80,000, but requests payment in advance
from the broker. With a transferable L /C, the broker can transfer $80,000 of the original L /C to the end supplier under the same terms and conditions, except for the
amount, the latest shipment date, the invoice, and the period of validity. When the end
supplier ships the product, it presents its documents to the bank. When the bank pays
the L /C, $80,000 is paid to the end supplier and $20,000 goes to the broker. In effect,
the broker has utilized the credit of the buyer to ﬁnance the entire transaction.
Another type of L /C is the assignment of proceeds. In this case, the original
beneﬁciary of the L /C pledges (or assigns) the proceeds under an L /C to the end
supplier. The end supplier has assurance from the bank that if and when documents are
presented in compliance with the terms of the L /C, the bank will pay the end supplier
according to the assignment instructions. This assignment is valid only if the beneﬁciary
presents documents that comply with the L /C. The end supplier must recognize that the
issuing bank is under no obligation to pay the end supplier if the original beneﬁciary
never ships the goods or fails to comply with the terms of the L /C. Banker’s Acceptance
Introduced earlier, a banker’s acceptance (shown in Exhibit 19.4) is a bill of exchange,
or time draft, drawn on and accepted by a bank. It is the accepting bank’s obligation to
pay the holder of the draft at maturity.
In the ﬁrst step in creating a banker’s acceptance, the importer orders goods from
the exporter. The importer then requests its local bank to issue an L /C on its behalf. The
L /C will allow the exporter to draw a time draft on the bank in payment for the exported goods. The exporter presents the time draft along with shipping documents to
its local bank, and the exporter’s bank sends the time draft along with shipping documents to the importer’s bank. The importer’s bank accepts the draft, thereby creating
the banker’s acceptance. If the exporter does not want to wait until the speciﬁed date to
receive payment, it can request that the banker’s acceptance be sold in the money
market. By doing so, the exporter will receive less funds from the sale of the banker’s acceptance than if it had waited to receive payment. This discount reﬂects the time value
A money market investor may be willing to buy the banker’s acceptance at a discount and hold it until payment is due. This investor will then receive full payment be- C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 571 Exhibit 19.4 Orlando, Florida, U.S.A. Colombia from U.S.A. Coffee Order of of Days after sight 2005 Pay to the Colombian Coffee Traders Ltd. One Million and 00/100 Dollars Drawn under International Bank L/C #155 Value received and charge the same account of To International Bank, N.A.
to Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 DRAFT Ninety (90) January 15 International Bank N.A.
Orlando, Florida U.S.A.
International Bank, N.A. 1,000,000
the transaction which gives to this
instrument is the importation $ A C C E PT E D Banker’s Acceptance Colombian Coffee Traders Ltd/
Bogota, Colombia cause the banker’s acceptance represents a future claim on funds of the bank represented
by the acceptance. The bank will make full payment at the date speciﬁed because it expects to receive this amount plus an additional fee from the importer.
If the exporter holds the acceptance until maturity, it provides the ﬁnancing for the
importer as it does with accounts receivable ﬁnancing. In this case, the key difference
between a banker’s acceptance and accounts receivable ﬁnancing is that a banker’s acceptance guarantees payment to the exporter by a bank. If the exporter sells the banker’s
acceptance in the secondary market, however, it is no longer providing the ﬁnancing for
the importer. The holder of the banker’s acceptance is ﬁnancing instead.
A banker’s acceptance can be beneﬁcial to the exporter, importer, and issuing bank.
The exporter does not need to worry about the credit risk of the importer and can therefore penetrate new foreign markets without concern about the credit risk of potential
customers. In addition, the exporter faces little exposure to political risk or to exchange
controls imposed by a government because banks normally are allowed to meet their
payment commitments even if controls are imposed. In contrast, controls could prevent
an importer from paying, so without a banker’s acceptance, an exporter might not receive payment even though the importer is willing to pay. Finally, the exporter can sell
the banker’s acceptance at a discount before payment is due and thus obtain funds up
front from the issuing bank.
The importer beneﬁts from a banker’s acceptance by obtaining greater access to foreign markets when purchasing supplies and other products. Without banker’s acceptances, exporters may be unwilling to accept the credit risk of importers. In addition, due
to the documents presented along with the acceptance, the importer is assured that
goods have been shipped. Even though the importer has not paid in advance, this assurance is valuable because it lets the importer know if and when supplies and other
products will arrive. Finally, because the banker’s acceptance allows the importer to pay
at a later date, the importer’s payment is ﬁnanced until the maturity date of the banker’s
acceptance. Without an acceptance, the importer would likely be forced to pay in advance, thereby tying up funds.
The bank accepting the drafts beneﬁts in that it earns a commission for creating an
acceptance. The commission that the bank charges the customer reﬂects the customer’s
perceived creditworthiness. The interest rate charged the customer, commonly referred
to as the all-in-rate, consists of the discount rate plus the acceptance commission. In 572 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T general, the all-in-rate for acceptance ﬁnancing is lower than prime-based borrowings,
as shown in the following comparison:
Loan Acceptance $1,000,000 $1,000,000 Term: 180 days 180 days Rate: Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 Amount: Prime 1.5% 10.0% 1.5% Interest cost: $57,500 BA rate
11.5% 7.60% 1.5%
1.5% 9.10% $45,500 In this case, the interest savings for a six-month period is $12,000. Since the banker’s
acceptance is a marketable instrument with an active secondary market, the rates on acceptances usually fall between the rates on short-term Treasury bills and the rates on
commercial paper. Investors are usually willing to purchase acceptances as an investment because of their yield, safety, and liquidity. When a bank creates, accepts, and sells
the acceptance, it is actually using the investor’s money to ﬁnance the bank’s customer.
As a result, the bank has created an asset at one price, sold it at another, and retained a
commission (spread) as its fee.
Banker’s acceptance ﬁnancing can also be arranged through the reﬁnancing of a
sight letter of credit. In this case, the beneﬁciary of the L /C (the exporter) may insist on
payment at sight. The bank arranges to ﬁnance the payment of the sight L /C under a
separate acceptance-ﬁnancing agreement. The importer (borrower) simply draws drafts
upon the bank, which in turn accepts and discounts the drafts. The proceeds are used
to pay the exporter. At maturity, the importer is responsible for repayment to the bank.
Acceptance ﬁnancing can also be arranged without the use of an L /C under a separate acceptance agreement. Similar to a regular loan agreement, it stipulates the terms
and conditions under which the bank is prepared to ﬁnance the borrower using acceptances instead of promissory notes. As long as the acceptances meet one of the underlying transaction requirements, the bank and borrower can utilize banker’s acceptances as
an alternative ﬁnancing mechanism. The life cycle of a banker’s acceptance is illustrated
in Exhibit 19.5. Working Capital Financing
As just explained, a banker’s acceptance can allow an exporter to receive funds immediately, yet allow an importer to delay its payment until a future date. The bank may even
provide short-term loans beyond the banker’s acceptance period. In the case of an importer, the purchase from overseas usually represents the acquisition of inventory. The
loan ﬁnances the working capital cycle that begins with the purchase of inventory and
continues with the sale of the goods, creation of an account receivable, and conversion
to cash. With an exporter, the short-term loan might ﬁnance the manufacture of the
merchandise destined for export (pre-export ﬁnancing) or the time period from when
the sale is made until payment is received from the buyer. For example, the ﬁrm may
have imported foreign beer, which it plans to distribute to grocery and liquor stores. The
bank can not only provide a letter of credit for trade ﬁnance, but it can also ﬁnance the
importer’s cost from the time of distribution and collection of payment. C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 573 Exhibit 19.5 Life Cycle of a Typical Banker’s Acceptance (B/A)
(1) Purchase Order
Mr. Sato Mr. Smith At Maturity Date of B/A (9) Payment–Discounted Value of B/A At and just after B/A Creation (6) Shipping Documents & Time Draft Prior to B/A Creation (4) L/C Notification (14) Payment–Face Value of B/A (11) Shipping Document (10) Signed Promissory Note for Face Value of B/A (2) L/C (Letter of Credit) Application Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 (5) Shipment of Cars (3) L/C
(7) Shipping Documents & Time Draft
American Bank (3) Draft Accepted (BA Created) Japanese Bank (8) Payment–Discounted Value of B/A (15) B/A Presented at Maturity
(16) Payment–Face Value of B/A Money Market
Investor (13) Payment–Discounted Value of B/A
(12) B/A Medium-Term Capital Goods Financing (Forfaiting)
Because capital goods are often quite expensive, an importer may not be able to make
payment on the goods within a short time period. Thus, longer-term ﬁnancing may be
required here. The exporter might be able to provide ﬁnancing for the importer but may
not desire to do so, since the ﬁnancing may extend over several years. In this case, a type
of trade ﬁnance known as forfaiting could be used. Forfaiting refers to the purchase of
ﬁnancial obligations, such as bills of exchange or promissory notes, without recourse to
the original holder, usually the exporter. In a forfait transaction, the importer issues a
promissory note to pay the exporter for the imported goods over a period that generally
ranges from three to seven years. The exporter then sells the notes, without recourse, to
the forfaiting bank. Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 574 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T In some respects, forfaiting is similar to factoring, in that the forfaiter (or factor) assumes responsibility for the collection of payment from the buyer, the underlying credit
risk, and the risk pertaining to the countries involved. Since the forfaiting bank assumes
the risk of nonpayment, it should assess the creditworthiness of the importer as if it were
extending a medium-term loan. Forfait transactions normally are collateralized by a
bank guarantee or letter of credit issued by the importer’s bank for the term of the transaction. Since obtaining ﬁnancial information about the importer is usually difﬁcult, the
forfaiting bank places a great deal of reliance on the bank guarantee as the collateral in
the event the buyer fails to pay as agreed. It is this guarantee backing the transaction that
has fostered the growth of the forfait market, particularly in Europe, as a practical means
of trade ﬁnance.
Forfaiting transactions are usually in excess of $500,000 and can be denominated in
most currencies. For some larger transactions, more than one bank may be involved. In
this case, a syndicate is formed wherein each participant assumes a proportionate share
of the underlying risk and proﬁt. A forfaiting ﬁrm may decide to sell the promissory
notes of the importer to other ﬁnancial institutions willing to purchase them. However,
the forfaiting ﬁrm is still responsible for payment on the notes in the event the importer
is unable to pay. Countertrade
The term countertrade denotes all types of foreign trade transactions in which the
sale of goods to one country is linked to the purchase or exchange of goods from that
same country. Some types of countertrade, such as barter, have been in existence for
thousands of years. Only recently, however, has countertrade gained popularity and importance. The growth in various types of countertrade has been fueled by large balanceof-payment disequilibriums, foreign currency shortages, the debt problems of less
developed countries and stagnant worldwide demand. As a result, many MNCs have
encountered countertrade opportunities, particularly in Asia, Latin America, and Eastern Europe. The most common types of countertrade include barter, compensation, and
Barter is the exchange of goods between two parties without the use of any currency
as a medium of exchange. Most barter arrangements are one-time transactions governed
by one contract. An example would be the exchange of 100 tons of wheat from Canada
for 20 tons of shrimp from Ecuador.
In a compensation or clearing-account arrangement, the delivery of goods to one
party is compensated for by the seller’s buying back a certain amount of the product
from that same party. The transaction is governed by one contract, and the value of the
goods is expressed in monetary terms. The buy-back arrangement could be for a fraction of the original sale (partial compensation) or more than 100 percent of the original
sale (full compensation). An example of compensation would be the sale of phosphate
from Morocco to France in exchange for purchasing a certain percentage of fertilizer. In
some countries, this is also referred to as an industrial cooperation arrangement. Such
arrangements often involve the construction of large projects, such as power plants, in
exchange for the purchase of the project’s output over an extended period of time. For
example, Brazil sold a hydroelectric plant to Argentina and in exchange purchased a percentage of the plant’s output under a long-term contract.
The term counterpurchase denotes the exchange of goods between two parties under
two distinct contracts expressed in monetary terms. Delivery and payment of both
goods are technically separate transactions. C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 575 Despite the economic inefﬁciencies of countertrade, it has become much more important in recent years. The primary participants are governments and MNCs, with assistance provided by specialists in the ﬁeld, such as attorneys, ﬁnancial institutions, and
trading companies. The transactions are usually large and very complex. Many variations of countertrade exist, and the terminology used by the various market participants
is still forming as the countertrade market continues to develop. Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 Agencies That Motivate International Trade
Due to the inherent risks of international trade, government institutions and the private
sector offer various forms of export credit, export ﬁnance, and guarantee programs to
reduce risk and stimulate foreign trade.
Three prominent agencies provide these services in the United States:
■ Export-Import Bank of the United States (Ex-Imbank)
Private Export Funding Corporation (PEFCO)
Overseas Private Investment Corporation (OPIC) Each of these agencies is described in turn. http://
.gov, the site of the
Export-Import Bank of
the United States, for
interest rates charged
by an export credit
agency. MANAGING Export-Import Bank of the United States
The Export-Import Bank was established in 1934 with the original goal of facilitating
Soviet-American trade. Its mission today is to ﬁnance and facilitate the export of American goods and services and maintain the competitiveness of American companies in
overseas markets. It operates as an independent agency of the U.S. government and, as
such, carries the full faith and credit of the United States. FOR VALUE Engelhard’s Selection of a Bank to Service Export Collections
Engelhard Corp. is a large chemical manufacturer in New
Jersey. It is one of the largest exporters in the United States
and frequently uses banks to facilitate its trade. On a typical day, it may have 15 to 20 letters of credit (L /Cs). As it
searched for a bank to facilitate its international trade
ﬁnancing, Engelhard established a set of requirements
that the bank must meet:
■ ■ The bank must provide a workstation where L /Cs are
stored as separate records.
The bank must be capable of electronically transferring L /C information to various sites and to the workstation.
The workstation must be accessible so that the ﬁrm
can check payment information on a timely basis. ■ The workstation must be able to retrieve L /C information pertaining to Engelhard’s business with any
ﬁrm over any particular period. Several banks bid for Engelhard’s business and assured the
company that they could provide the services needed. As
a result of Engelhard’s efforts to communicate its needs, it
now has electronic access to much more information and
can easily monitor its trade ﬁnancing positions with each
of its importers. This allows it to make more informed decisions about the terms of trade that it negotiates with
each customer and thus enables it to maximize its value. 576 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 The Ex-Imbank’s programs are typically designed to encourage the private sector to
ﬁnance export trade by assuming some of the underlying credit risk and providing direct ﬁnancing to foreign importers when private lenders are unwilling to do so. To satisfy these objectives, the Ex-Imbank offers programs that are classiﬁed as (1) guarantees,
(2) loans, (3) bank insurance, and (4) export credit insurance. http://
The website http://
has a section on international markets that
offers quotations of
short-term foreign interest rates. This information is useful to an
MNC that needs to
ﬁnance its short-term
liquidity needs. Guarantee Programs. The two most widely used guarantee programs are the Working
Capital Guarantee Program and the Medium-Term Guarantee Program. The Working Capital Guarantee Program encourages commercial banks to extend short-term export
ﬁnancing to eligible exporters by providing a comprehensive guarantee that covers 90
to 100 percent of the loan’s principal and interest. This guarantee protects the lender
against the risk of default by the exporter. It does not protect the exporter against the
risk of nonpayment by the foreign buyer. The loans are fully collateralized by export
receivables and export inventory and require the payment of guarantee fees to the ExImbank. The export receivables are usually supported with export credit insurance or a
letter of credit.
The Guarantee Program encourages commercial lenders to ﬁnance the sale of U.S.
capital equipment and services to approved foreign buyers. The Ex-Imbank guarantees
100 perent of the loan’s principal and interest. The ﬁnanced amount cannot exceed 85
percent of the contract price. This program is designed to ﬁnance products sold on a medium-term basis, with repayment terms of generally between one and ﬁve years. The
guarantee fees paid to the Ex-Imbank are determined by the repayment terms and the
buyer’s risk. The Ex-Imbank now offers a leasing program to ﬁnance capital equipment
and related services.
Loan Programs. Two of the most popular loan programs are the Direct Loan Program and
the Project Finance Loan Program. Under the Direct Loan Program, Ex-Imbank offers
ﬁxed rate loans directly to the foreign buyer to purchase U.S. capital equipment and services on a medium-term or long-term basis. The total ﬁnanced amount cannot exceed
85 percent of the contract price. Repayment terms depend upon the amount but are typically one to ﬁve years for medium-term transactions and seven to ten years for longterm transactions. The Ex-Imbank’s lending rates are generally below market rates.
The Project Finance Loan Program allows banks, the Ex-Imbank, or a combination
of both to extend long-term ﬁnancing for capital equipment and related services for major projects. These are typically large infrastructure projects, such as power generation
projects, whose repayment depends on project cash ﬂow. Major U.S. corporations are
often involved in these types of projects. The program typically requires a 15 percent
cash payment by the foreign buyer and allows for guarantees of up to 85 percent of the
contract amount. The fees and interest rates vary depending on the project risk.
Bank Insurance Programs. The Ex-Imbank offers several insurance policies to banks.
The most widely used is the Bank Letter of Credit Policy. This policy enables banks to
conﬁrm letters of credit issued by foreign banks supporting a purchase of U.S. exports.
Without this insurance, some banks would not be willing to assume the underlying
commercial and political risk associated with conﬁrming an L /C. The banks are insured
up to 100 percent for sovereign (government) banks and 95 percent for all other banks.
The insurance premium is based on the type of buyer, repayment term, and country.
The Financial Institution Buyer Credit Policy is issued in the name of the bank. This
policy provides insurance coverage for loans by banks to foreign buyers on a short-term
basis. A variety of short-term and medium-term insurance policies are available to ex- Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 577 porters, banks, and other eligible applicants. Basically, all the policies provide insurance
protection against the risk of nonpayment by foreign buyers. If the foreign buyer fails to
pay the exporter because of commercial reasons such as cash ﬂow problems or insolvency, the Ex-Imbank will reimburse the exporter between 90 and 100 percent of the
insured amount, depending on the type of policy and buyer.
If the loss is due to political factors, such as foreign exchange controls or war, the
Ex-Imbank will reimburse the exporter for 100 percent of the insured amount. Exporters can use the insurance policies as a marketing tool because the insurance enables
them to offer more competitive terms while protecting them against the risk of nonpayment. An exporter can also use the insurance policy as a ﬁnancing tool by assigning the
proceeds of the policy to a bank as collateral. Certain restrictions may apply to particular countries, depending on the Ex-Imbank’s experience, as well as existing economic
and political conditions.
Export Credit Insurance. The Small Business Policy provides enhanced coverage to new
exporters and small businesses. The policy insures short-term credit sales (under 180
days) to approved foreign buyers. In addition to providing 95 percent coverage against
commercial risk defaults and 100 percent against political risk, the policy offers lower
premiums and no annual commercial risk loss deductible. The exporter can assign the
policy to a bank as collateral.
The Umbrella Policy operates in a slightly different manner. The policy itself is issued
to an “administrator,” such as a bank, trading company, insurance broker, or government agency. The policyholder administers the policy for multiple exporters and relieves
the exporters of the administrative responsibilities associated with the policy. The shortterm insurance protection is similar to that provided by the Small Business Policy and
does not have a commercial risk deductible. The proceeds of the policy may be assigned
to a bank for ﬁnancing purposes.
The Multi-Buyer Policy is used primarily by experienced exporters. It provides insurance coverage on short-term export sales to many different buyers. Premiums are based
on an exporter’s sales proﬁle, credit history, terms of repayment, country, and other factors. Based on the exporter’s experience and the buyer’s creditworthiness, the Ex-Imbank
may grant the exporter authority to preapprove speciﬁc buyers up to a certain limit.
The Single-Buyer Policy allows an exporter to selectively insure certain short-term
transactions to preapproved buyers. Premiums are based on repayment terms and transaction risk. There is also a Medium-Term Policy to cover sales to a single buyer for terms
of between one and ﬁve years.
The Ex-Imbank has also entered into partnership arrangements with more than 30
states to disseminate government trade promotion services to a broader audience. For
example, in Florida, the Florida Export Finance Corp. provides export credit insurance
consulting, trade ﬁnance, and guarantees to exporters based in Florida.
Several private insurance carriers, such as AIG, also provide various types of insurance policies that may be used to mitigate risk. They are frequently employed when ExImbank insurance is not available or desirable. Private Export Funding Corporation (PEFCO)
PEFCO, a private corporation, is owned by a consortium of commercial banks and industrial companies. In cooperation with the Ex-Imbank, PEFCO provides medium- and
long-term ﬁxed rate ﬁnancing to foreign buyers. The Ex-Imbank guarantees all export 578 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 loans made by PEFCO. Most PEFCO loans are to ﬁnance large projects, such as aircraft
and power generation equipment, and as a result have very long terms (5 to 25 years).
Since commercial banks usually do not extend such long terms, PEFCO ﬁlls a void in
the market. PEFCO also serves as a secondary market buyer of export loans originated
by U.S. banks. PEFCO raises its funds in the capital markets through the issuance of
long-term bonds. These bonds are readily marketable since they are in effect secured by
Ex-Imbank-guaranteed loans. Overseas Private Investment Corporation (OPIC)
OPIC, formed in 1971, is a self-sustaining federal agency responsible for insuring direct
U.S. investments in foreign countries against the risks of currency inconvertibility, expropriation, and other political risks. Through the direct loan or guaranty program,
OPIC will provide medium- to long-term ﬁnancing to U.S. investors undertaking an
overseas venture. In addition to the general insurance and ﬁnance programs, OPIC offers speciﬁc types of coverage for exporters bidding on or performing foreign contracts.
American contractors can insure themselves against contractual disputes and even the
wrongful calling of standby letters of credit. SUMMARY
■ ■ The common methods of payment for international
trade are (1) prepayment (before goods are sent),
(2) letters of credit, (3) drafts, (4) consignment, and
(5) open account.
The most popular methods of ﬁnancing international trade are (1) accounts receivable ﬁnancing,
(2) factoring, (3) letters of credit, (4) banker’s acceptances, (5) working capital ﬁnancing, (6) me- dium-term capital goods ﬁnancing (forfaiting), and
■ The major agencies that facilitate international
trade with export insurance and/or loan programs
are (1) Export-Import Bank, (2) Private Export
Funding Corporation, and (3) Overseas Private Investment Corporation. POINT COUNTER-POINT
Do Agencies That Facilitate International Trade Prevent Free Trade?
Point Yes. The Export-Import Bank of the United States
provides many programs to help U.S. exporters conduct international trade. The government is essentially
subsidizing the exports. Governments in other countries have various programs as well. Thus, some countries may have a trade advantage because their exporters
are subsidized in various ways. These subsidies distort
the notion of free trade.
Counter-Point No. It is natural for any government to fa- cilitate exporting for relatively inexperienced exporting
ﬁrms. All governments provide a variety of services for their ﬁrms, including public services, and tax breaks
for producing products that are ultimately exported.
There is a difference between facilitating the exporting
process and protecting an industry from foreign competition. The protection of an industry violates the notion of free trade, but facilitating the exporting process
Who Is Correct? Use InfoTrac or some other search en- gine to learn more about this issue. Which argument do
you support? Offer your own opinion on this issue. C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E 579 SELF TEST
2. Explain the difference in the risk to the exporter between accounts receivable ﬁnancing and factoring. 1. Explain why so many international transactions require international trade credit facilitated by commercial banks.
Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 Answers are provided in Appendix A at the back of
the text. 3. Explain how the Export-Import Bank can encourage U.S. ﬁrms to export to less developed countries
where there is political risk. QUESTIONS AND APPLICATIONS
1. Banker’s Acceptances.
a. Describe how foreign trade would be affected if banks did not provide trade-related services.
b. How can a banker’s acceptance be beneﬁcial to an exporter, an importer, and a bank?
2. Export Financing.
a. Why would an exporter provide ﬁnancing for an importer?
b. Is there much risk in this activity? Explain. 3. Role of Factors.
a. What is the role of a factor in international trade
transactions? 4. Export-Import Bank.
a. What is the role today of the Export-Import Bank
of the United States?
b. Describe the Direct Loan Program administered by the Export-Import Bank.
5. Bills of Lading. What are bills of lading, and how do
they facilitate international trade transactions?
6. Forfaiting. What is forfaiting? Specify the type of
traded goods for which forfaiting is applied.
7. PEFCO. Brieﬂy describe the role of the Private Export Funding Corporation (PEFCO).
8. Government Programs. This chapter described many
forms of government insurance and guarantee programs. What motivates a government to establish
so many programs?
9. Countertrade. What is countertrade?
10. Impact of September 11. Every quarter, Bronx Co.
ships computer chips to a ﬁrm in central Asia. It has not used any trade ﬁnancing because the importing
ﬁrm always pays its bill in a timely manner upon
receipt of the computer chips. After the September 11, 2001 terrorist attack on the United States,
Bronx reconsidered whether it should use some
form of trade ﬁnancing that would ensure that it
would be paid for its exports upon delivery. Offer
a suggestion to Bronx Co. on how it could achieve
11. Working Capital Guarantee Program. Brieﬂy describe
the Working Capital Guarantee Program administered by the Export-Import Bank.
12. Small Business Policy. Describe the Small Business
13. OPIC. Describe the role of the Overseas Private Investment Corporation (OPIC).
ADVANCED QUESTIONS 14. Letters of Credit. Ocean Traders of North America is
a ﬁrm based in Mobile, Alabama, that specializes in
seafood exports and commonly uses letters of credit
(L /Cs) to ensure payment. It recently experienced a
problem, however. Ocean Traders had an irrevocable L /C issued by a Russian bank to ensure that it
would receive payment upon shipment of 16,000
tons of ﬁsh to a Russian ﬁrm. This bank backed out
of its obligation, however, stating that it was not authorized to guarantee commercial transactions.
a. Explain how an irrevocable L /C would normally facilitate the business transaction between the Russian importer and Ocean Traders of North America
(the U.S. exporter).
b. Explain how the cancellation of the L /C could
create a trade crisis between the U.S. and Russian
ﬁrms. 580 PA RT 5 • S H O RT- T E R M A S S E T A N D L I A B I L I T Y M A N AG E M E N T c. Why do you think situations like this (the can- information about trade ﬁnancing. Its address is cellation of the L /C) are rare in industrialized countries? http://www.exim.gov. Summarize what the Ex- d. Can you think of any alternative strategy that the U.S. exporter could have used to protect itself better when dealing with a Russian importer? Imbank does to facilitate trade by businesses.
DISCUSSION IN THE BOARDROOM This exercise can be found in Appendix E at the back of
this textbook. INTERNET APPLICATION Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 RUNNING YOUR OWN MNC 15. Trade and the Import-Export Bank. The website of
the Export-Import Bank of the United States offers This exercise can be found on the Xtra! website at
http://maduraxtra.swlearning.com. BLADES, INC. CASE
Assessment of International Trade Financing in Thailand
Blades, Inc., has recently decided to establish a subsidiary in Thailand to produce “Speedos,” Blades’
primary roller blade product. In establishing the subsidiary in Thailand, Blades was motivated by the high
growth potential of the Thai roller blade market. Furthermore, Blades has decided to establish a subsidiary,
as opposed to acquiring an existing Thai roller blade
manufacturer for sale, in order to maintain its ﬂexibility and control over the operations in Thailand. Moreover, Blades has decided to issue yen-denominated
notes to partially ﬁnance the cost of establishing the
subsidiary. Blades has decided to issue notes denominated in yen instead of baht to avoid the high effective
interest rates associated with the baht-denominated
Currently, Blades plans to sell all roller blades manufactured in Thailand to retailers in Thailand. Furthermore, Blades plans to purchase all components for
roller blades manufactured in Thailand from Thai suppliers. Similarly, all of Blades’ roller blades manufactured in the United States will be sold to retailers in the
United States and all components needed for Blades’
U.S. production will be purchased from suppliers in the
United States. Consequently, Blades will have no exports and imports once the plant in Thailand is operational, which is expected to occur early next year.
Construction of the plant in Thailand has already
begun, and Blades is currently in the process of purchasing the machinery necessary to produce Speedos.
Besides these activities, Ben Holt, Blades’ chief ﬁnancial
ofﬁcer (CFO), has been actively lining up suppliers of
the needed rubber and plastic components in Thailand
and identifying Thai customers, which will consist of
various sports product retailers in Thailand. Although Holt has been successful in locating both
interested suppliers and interested customers, he is discovering that he has neglected certain precautions for
operating a subsidiary in Thailand. First, although
Blades is relatively well known in the United States, it
is not recognized internationally. Consequently, the
suppliers Blades would like to use in Thailand are not
familiar with the ﬁrm and have no information about its
reputation. Moreover, Blades’ previous activities in
Thailand were restricted to the export of a ﬁxed number of Speedos annually to one customer, a Thai retailer
called Entertainment Products. Holt has little information about the potential Thai customers that would buy
the roller blades produced by the new plant. He is
aware, however, that although letters of credit (L /Cs)
and drafts are usually employed for exporting purposes, these instruments are also used for trade within
a country between relatively unknown parties.
Of the various potential customers Blades has
identiﬁed in Thailand, four retailers of sports products
appear particularly interested. Because Blades is not familiar with these ﬁrms and their reputations, it would
like to receive payment from them as soon as possible.
Ideally, Blades would like its customers to prepay for
their purchases, as this would involve the least risk for
Blades. Unfortunately, none of the four potential customers have agreed to a prepayment arrangement. In
fact, one potential customer, Cool Runnings, Inc., insists on an open account transaction. Payment terms in
Thailand for purchases of this type are typically “net
60,” indicating that payment for the roller blades would
be due approximately two months after a purchase was
made. Two of the remaining three retailers, Sports
Equipment, Inc., and Major Leagues, Inc., have indi- Madura, International Financial Management, Abridged 8/e, Mason, OH: Thomson South-Western, 2007 C H A P T E R 1 9 • F I N A N C I N G I N T E R N AT I O N A L T R A D E cated that they would also prefer an open account
transaction; however, both of these retailers have indicated that their banks would act as intermediaries for a
time draft. The fourth retailer, Sports Gear, Inc., is indifferent as to the speciﬁc payment method but has indicated to Blades that it ﬁnds a prepayment arrangement unacceptable.
Blades also needs a suitable arrangement with its
various potential suppliers of rubber and plastic components in Thailand. Because Blades’ ﬁnancing of the
Thai subsidiary involved a U.S. bank, it has virtually no
contacts in the Thai banking system. Because Blades is
relatively unknown in Thailand, Thai suppliers have indicated that they would prefer prepayment or at least a
guarantee from a Thai bank that Blades will be able to
make payment within 30 days of purchase. Blades does
not currently have accounts receivable in Thailand. It
does, however, have accounts receivable in the United
States resulting from its U.S. sales.
Ben Holt would like to please Blades’ Thai customers and suppliers in order to establish strong business relationships in Thailand. However, he is worried
that Blades may be at a disadvantage if it accepts all of
the Thai ﬁrms’ demands. Consequently, he has asked
you, a ﬁnancial analyst for Blades, Inc., to provide him
with some guidance regarding international trade
ﬁnancing. Speciﬁcally, Holt has asked you to answer
the following questions for him: 581 Leagues, Inc., would Blades receive payment for its
roller blades before it delivers them? Do the banks
issuing the time drafts guarantee payment on behalf
of the Thai retailers if they default on the payment?
2. What payment method should Blades suggest to
Sports Gear, Inc.? Substantiate your answer.
3. What organization could Blades contact in order to
insure its sales to the Thai retailers? What type of
insurance does this organization provide?
4. How could Blades use accounts receivable ﬁnancing or factoring, considering that it does not currently have accounts receivable in Thailand? If
Blades uses a Thai bank to obtain this ﬁnancing,
how do you think the fact that Blades does not have
receivables in Thailand would affect the terms of
5. Assuming that Blades is unable to locate a Thai
bank that is willing to issue an L /C on Blades’ behalf, can you think of a way Blades could utilize its
bank in the United States to effectively obtain an
L /C from a Thai bank?
6. What organizations could Blades contact to obtain
working capital ﬁnancing? If Blades is unable to obtain working capital ﬁnancing from these organizations, what are its other options to ﬁnance its working capital needs in Thailand? 1. Assuming that banks in Thailand issue a time draft
on behalf of Sports Equipment, Inc., and Major SMALL BUSINESS DILEMMA
Ensuring Payment for Products Exported by the Sports Exports Company
The Sports Exports Company produces footballs and
exports them to a distributor in the United Kingdom. It
typically sends footballs in bulk and then receives payment after the distributor receives the shipment. The
business relationship with the distributor is based on
trust. Although the relationship has worked thus far,
Jim Logan (owner of the Sports Exports Company) is
concerned about the possibility that the distributor will
not make its payment.
1. How could Jim use a letter of credit to ensure that
he will be paid for the products he exports? 2. Jim has discussed the possibility of expanding his
export business through a second sporting goods
distributor in the United Kingdom; this second distributor would cover a different territory than the
ﬁrst distributor. The second distributor is only willing to engage in a consignment arrangement when
selling footballs to retail stores. Explain the risk to
Jim beyond the typical types of risk he incurs when
dealing with the ﬁrst distributor. Should Jim pursue this type of business? ...
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- Spring '10