DOCUMENTS IN INTERNATIONAL TRADE

International (Foreign) Trade

Foreign trade is exchange of capital, goods, and services across international borders
or territories. In most countries, it represents a significant share of gross domestic
product (GDP).

Generally no country is self-sufficient. It has to depend upon other countries for

importing the goods which are either non-available with it or are available in
insufficient quantities. Similarly, it can export goods, which are in excess quantity
with it and are in high demand outside.

International trade means trade between the two or more countries. International
trade involves different currencies of different countries and is regulated by laws,
rules and regulations of the concerned countries. Thus, International trade is more
complex.

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 IRREVOCABLE LETTERS OF CREDIT

This section is a discussion of the documents that accompany the flow of goods from seller to
buyer. It did not discuss how the seller is paid.

In many simple transactions, goods and money are exchanged simultaneously. Or the seller
knows the buyer and is willing to trust him to make payment at a later date. In either case, the
buyer pays the seller directly.

But, in many situations, especially when the buyer and the seller are in different countries, the
seller may have the following reservations:

o He does not know the buyer.

o He does not know if the buyer will be able to pay him.
o He does not want to wait for payment until the buyer receives the goods.
o He does not want the payment to be dependent on the ability of the buyer to
obtain the money of the exporter’s countries.
o He does not want to be affected by changes of government regulation in the
country of importation which would impair the buyer’s ability to pay for the goods.

In such a situation, buyer and seller may agree on a different method of payment – via letter of
credit.

Here is an example of this kind of transaction:

Ms. Steiner in New York orders computer parts from Mr. Matsui in Tokyo. They agree
that Ms. Steiner will make payment via a letter of credit.

Ms. Steiner goes to her bank in New York and asks the bank to issue a letter of credit. She
tells the bank what terms she and Mr. Matsui have agreed upon.

Ms. Steiner’s bank issues a letter of credit and forwards it to a bank in Tokyo near Mr.
Matsui. At this point, Ms. Steiner has not paid anything for the goods although she paid
the bank a fee for the service.

The Tokyo bank sends the letter of credit to Mr. Matsui.

PRODUCTION
Mr. Matsui ships the goods.

Mr. Matsui brings in the documents specified in the letter of credit (including a
commercial invoice and a transport document). The Tokyo bank finds them in order and
pays Mr. Matsui.

The Tokyo bank sends the documents to Ms. Steiner’s bank in New York. The New York
bank examines the documents and finds that they are in order and reimburses the bank
in Tokyo.

Ms. Steiner pays the bank in New York, which now turns the documents over to her.

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 MOVEMENT OF GOODS AND DOCUMENTS – A REVIEW

Mr. Jones has dealt with Ms. Arden for many years. Mr. Jones knows he will be
paid as soon as Ms. Arden receives the documents covering a specific shipment.
The transaction involves:

transport document
carrier
commercial invoice
consignee
shipper

Using the words from the list above, show how the goods and documents move
between Mr. Jones and Ms. Arden. (Remember: You can use each word more than
once and you can use more than one word in each answer)

(5)

money

goods goods

(1) (2) (3)

(4)

1. ______________________
2. ______________________
3. ______________________
4. ______________________
5. ______________________

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Situation 1

Mr. Harding assembles stereo components into complete stereo systems and sells them.
He would like to purchase some custom-made cabinets from Mr. Lansing. Mr. Lansing
refuses to accept the order because he does not know Mr. Harding and is afraid he may
not be paid for his work.

Whose credit is being questioned?

a. buyer’s credit
b. seller’s credit

Situation 2

Mr. Harding asks his bank to issue a letter of credit in favor of Mr. Lansing. The bank
issues the letter of credit, which contains the bank’s promise to pay the seller if he
complies with the conditions in the letter of credit.

Mr. Lansing then ships the goods. He is relying on:

a. Mr. Harding’s credit

b. The bank’s credit

A letter of credit that contains the bank’s promise to pay is called an irrevocable
letter of credit because it cannot be changed or canceled without the agreement of all
parties: buyer, seller, and bank.

There is also a revocable letter of credit, which is sometimes called a revocable advice. It
can be changed or canceled without the consent of the seller. These are very rare and they
will not be covered in this course.

When a bank issues a letter of credit, it is substituting its promise to pay the seller for
that of the buyer. The bank must, therefore, satisfy itself that the credit of the buyer is
good and the bank will be repaid.

Where should the buyer apply for a letter of credit?

a. A bank where the buyer’s credit is known.

b. A bank where the seller’s credit is known.

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 documents

Seller Bank
money

documents

Bank Buyer
money

RULE OF THE THUMB

When a letter of credit is used to buy merchandise, payment is made on

receipt of the documents specified in the letter of credit.

Situation 3

A. Jackson Construction Co. purchases tiles from the Naples Terazzo Co. in
Italy. Payment is made via a letter of credit.

When does the bank pay?

a. when Jackson Construction Co. receives goods.
b. when Naples Terazzo Co. presents documents.

When does Jackson Construction Co. pay?

a. when it gets Naples Terazzo Co.’s documents
b. when the bank issues the letter of credit.

Whom does Jackson Construction Co. pay?

a. Naples Terazzo Co.
b. The bank

In a letter of credit transaction, payments are made in exchange for:

a. goods
b. documents
c. services

B. Allard Co. pays for goods shipped by Terangi Co. via a letter of credit.

Number the steps in the transaction in the order in which they occur

………………….. Allard Co. pays bank

………………….. Bank issues letter of credit
………………….. Bank pays Tarangi Co.

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An irrevocable letter of credit
- a bank’s assurance of payment to a seller

When a seller receives an irrevocable letter of credit to ensure payment for his goods, he does not
have to worry about the reputation or the credit standing of the buyer. He will be paid by the
bank.

A bank pays when the documents are in order. As long as the seller presents
documents in agreement with the letter of credit, he will be paid.

RULE OF THE THUMB

Banks deal with documents, not goods.

Situation 4

Consider the following situations involving irrevocable letters of credit:

1. A bank finds that the documents the seller presented agree with the letter of credit and
are therefore in order. The buyer contends that the shipment is of inferior quality. Will
the bank pay the seller?

2. The seller fills his order with the correct merchandise. He presents his documents to the
bank, but one document is missing. Will the bank pay the seller?

3. The seller presents to the bank all the documents called for in the letter of credit. But the
buyer declared bankruptcy a few days earlier. Will the bank pay the seller?

If the bank has found the documents to be in order and paid the seller, the buyer
must repay the bank.

What do you think?

1. The seller presents to the bank a transport document and a commercial invoice that
appear to be in order. The bank pays the seller. The buyer somehow learns that the goods
being shipped are of inferior quality. Is the buyer obligated to pay the bank?

2. In a letter of credit transaction, the bank pays the seller for:

a. documents that agree with the letter of credit

b. merchandise that the buyer ordered

3. Will a letter of credit protect a buyer from a dishonest seller who sends goods of inferior
quality? Explain your answer.

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Once the seller receives the letter of credit, he can prepare his merchandise for shipment.

Transport document
Commercial invoice
Money

Using the diagram, fill in the blanks to show the movement of documents and money now that
the seller has the letter of credit. Use words from the list above. (Some words may be used more
than once and some words will be repeated)

Bank
(2)

(5)
(3) (4)

goods goods
Seller Carrier Buyer

(1)
____________________________
____________________________
____________________________
____________________________
Situation 5 ____________________________

1. R.S. Williams wants to purchase ceramic tiles from the T.M. Building Supply Co. Who will
apply for the letter of credit?

a. R.S. Williams
b. T.M. Building Supply Co.

2. A.L. Smith applies for a letter of credit. The bank issues the letter of credit and mails it to
T.G. Thomas. Ms. Thomas is the:

a. buyer
b. seller

3. Marie Williams has ordered some coffee from Brazil. Payment will be made via a letter of
credit. When will Ms. Williams pay for the coffee?

a. when she receives the shipment of coffee

b. when the bank has the proper documents covering the shipment

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In a letter of credit, the party applying for the letter of credit is the applicant.

The party to whom the letter of credit is addressed is the beneficiary.

The bank that issues the letter of credit for the applicant is the issuing bank.

Refer to the letter of credit on the opposite page,

1. Identify each of the parties to this letter of credit

 Applicant ………………………………….
 Beneficiary ………………………………..
 Issuing bank ………………………………

2. What is the buyer’s name in this transaction?

3. What is the seller’s name?

4. The person who applies for a letter of credit wants:

a. goods in return for money
b. money in return for goods

5. The applicant is the buyer. The beneficiary is the seller. Who applies for the letter of credit?
a. applicant
b. beneficiary

Mr. Stevens wants to purchase lumber from the Tentex Logging Co. Mr. Stevens
and Tentex Logging Co. agree that a letter of credit will be used for payment.

Who is the applicant?

a. Mr. Stevens b. Tentex Logging Co.

Mr. Stevens does all of his banking at Bank A. The Tentex Logging Co. maintains its accounts at
Bank B. Which bank will be the issuing bank?
a. Bank A
b. Bank B

Alabama Cotton sells 40 bales of cotton to Ann Samuels. Payment will be made with a letter of
credit. Who is the beneficiary?
a. Alabama Cotton
b. Ann Samuels

Match
………….…. applicant A. buyer
…………….. beneficiary B. buyer’s bank
…………….. issuing bank C. seller
D. seller’s bank
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 Refer to the letter of credit provided.

The letter of credit tells the beneficiary which documents he must present to be
paid. It also tells him what information must appear on the documents.

1. What documents must be presented by Adam Taylor Associates, the beneficiary of the letter of
credit on the opposite page?

2. What is the bank paying the beneficiary for?

a. 2 gross of men’s sport shirts
b. documents covering a shipment of shirts.

3. Will a letter of credit protect a buyer from a dishonest seller who sends goods of inferior
quality? Explain your answer.

In addition to the documents required by the buyer as evidence of shipment, the bank usually
requires a document called a draft.

The document at the bottom of this page is a draft, which is a demand for payment.

The company or person who makes out and signs the draft is called the drawer of the draft,
just as the person who makes out a check is the drawer of the check.

Draw under Morgan Guaranty Trust Company of New York Letter of Credit No. S – 3086

$ 2,400.00 New York August 5, 20…..

At sight Pay to the Order of

Adam Taylor Associate

Two thousand four hundred and 00/100 Dollars

To:
Morgan Guaranty Trust Company of New York Adam Taylor Associates
New York
Adam Taylor

Refer to the draft above. It was drawn in accordance with the instructions in the letter of credit
on the preceding page.

1. Which company is the drawer of the draft?

2. The drawer of the draft is the __________

a. applicant of the letter of credit
b. beneficiary of the letter of credit
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 3. The applicant is the _____________
a. buyer
b. seller

4. She wants _____________

c. goods
d. money

5. The beneficiary is the _____________

a. buyer
b. seller

6. He wants _____________
a. goods
b. money

7. Who is the drawer of the draft?

a. applicant
b. beneficiary

$ 5,000.00 US Chicago,January28,19…..

At sight Pay to the Order of

V. Williams

Five thousand and 00/100 Dollars

To:
The First National Bank of Chicago R. Ryck and Company
Chicago, Illinois
R. Rych

The party who signs the draft is the drawer of the draft.

The party who is paid by the bank is the payee.

When a draft is issued under a letter of credit, the drawer and the payee are usually the same
party.

The party who draws the draft must be the beneficiary of the letter of credit. In the next few
exercises they will be different parties just for the purpose of clarifying the technical terms used
to identify them.

Refer to the draft at the top of the frame (which is not part of a letter of credit transaction) and
identify each of the following parties:

1. Drawer ……………………. 2. Payee ………………………

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$ 1,000.00 US Boston,March 20,19…..

At sight Pay to the Order of

G. Sherman

One thousand and 00/100 Dollars

To:
The First National Bank of Boston Abraham Smith and Sons
Boston, Mass.

Abraham Smith

The party from whom payment is demanded is called the drawee.

Refer to the draft at the top of the frame and identify each of the following parties:

1. drawee ……………………………….
2. drawer ……………………………….
3. payee ……………………………….

Refer to the letter of credit on the opposite page.

Sometimes the same bank will issue the letter of credit and pay the beneficiary. This will most
often happen when both the buyer and the seller are near the bank. Many times, however, such as
when the buyer and the seller are in different countries, two different banks perform these
functions.

The bank that issues the letter of credit is the issuing bank.

The bank on which the draft will be drawn is the drawee bank. It is also called the paying
bank.

Identify the following from the letter of credit on the opposite page.

1. drawee bank …………………………

2. issuing bank …………………………
3. paying bank ………………………....
4. applicant …………………………….
5. beneficiary …………………………..
6. drawer of draft ………………………
7. buyer ………………………………..
8. seller ………………………………..

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The Bank of New York opens a letter of credit. The beneficiary presents his documents to the
Bank in Rudesheim, which then sends them on to the Bank in Munich. The draft is drawn on the
Bank in Munich.

Identify the following:

1. Issuing bank ……………………………
2. Paying bank ……………………………

Morgan Guaranty Trust Company of New York opens a letter of credit. The beneficiary
presents his documents to the Bank in Paris, which then sends them to Morgan Guaranty Trust
Company of New York. The draft is drawn on Morgan Guaranty Trust Company of New York.

Identify the following:

1. Issuing bank …………………………..

2. Paying bank …………………………..

Bank in Paris Credit RB - 100

$ 1,569.00 US New York January 2 20…..

At sight Pay to the Order of

Richard R. Topper Associates

One thousand five hundred sixty-nine and 00/100 Dollars

To:
Chemical bank Richard R. Topper Associates
New York, NY

Richard Topper

1. This is a:
a. transport document
b. draft
c. letter of credit

2. The document indicates that Chemical Bank is the:

a. drawee bank
b. issuing bank

3. What does this document demand?

a. documents
b. goods
c. payment

Identify each of the following as buyer or seller. Assume there are no other parties involved
except the bank.

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 1. Applicant ……………………………….
2. Beneficiary ……………………………….
3. Consignee ……………………………….
4. Drawer ……………………………….
5. Exporter ……………………………….
6. Importer ……………………………….
7. Payee ……………………………….
8. Shipper ……………………………….

What is a draft?

a. demand for payment

b. promise of payment

Match the document with the document’s description:

A. transport document ___ contract for delivery of merchandise

B. commercial invoice ___ demand for payment
C. draft ___ statement describing the
merchandise, its cost, and shipping charges
D. letter of credit

All letters of credit have a time limit. The beneficiary must present her documents before the
letter of credit expires or she will lose the bank’s assurance of payment.

The last date on which the beneficiary can present documents and be certain she will be paid if
the documents are in order is called the expiry date of the letter of credit.

1. The expiry date of the letter of credit is Friday, September 23. The beneficiary presents
documents in order on September 20. Does she still have the bank’s assurance of
payment?

2. The expiry date is Monday, May 12. The beneficiary presents documents in order on May
13. Does she still have the bank’s assurance of payment?

3. The expiry date is Tuesday June 5. The beneficiary presents documents in order on June 5.
Does she still have the bank’s assurance of payment?

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In addition to the expiry date there is a presentation period during which documents must be
presented. A presentation period is a specified period of time after the date of shipment shown
on the transport document. This is to be sure that the documents will be presented promptly so
that they will be in the buyer’s possession before the vessel arrives.

The bottom of a letter of credit shows something like the following:

Documents are to be presented within 18 days of shipment but within the validity of the credit

If no period of time is stipulated in the letter of credit, the documents must be presented within
21 days of the date of shipment shown on the transport document.

1. The expiry date on a letter of credit is Friday, March 28. The letter of credit
also requires documents to be presented within 15 days of the date of shipment
shown on the transport document. The beneficiary presents documents in
order on March 20 with the transport document showing the date of shipment
as March 10. Will the bank pay the beneficiary?
2. The expiry date is Tuesday, August 12 with presentation to be made within 10
days of the shipping date. The beneficiary presents documents in order on
August 9 with the transport document showing the date of shipment to be July
27. Will the bank pay the beneficiary?
3. The expiry date is Monday, October 15 with no presentation period specified.
The beneficiary presents documents in order on October 12 with a transport
having a shipping date of September 25. Will the bank pay the beneficiary?
4. The expiry date is Wednesday, May 10 with presentation to be made within 15
days of the shipping date. The beneficiary presents documents in order on May
11 with a transport with a shipment date of May 1. Will the bank pay the
beneficiary?

The beneficiary must do two things to be paid. He must present document that conform to the
letter of credit and he must present them on time (on or before the expiry date and within the
presentation period).

1. The expiry date of a letter of credit is Wednesday, September 30. The beneficiary presents
documents on September 30. The documents agree with the requirements in the letter of
credit. The shipping date is August 30. No presentation period is mentioned. Will the
bank pay the beneficiary? If not, explain your answer.
2. The expiry date of a letter of credit is Monday, July 17. The beneficiary presents
documents on July 18. The documents agree with the requirements in the letter of credit.
The shipping date is July 15. The letter of credit says that presentation must be made
within 10 days of the shipping date. Will the bank pay the beneficiary? If not, explain your
answer.
3. The expiry date of a letter of credit is Wednesday, January 27. The beneficiary presents
documents on January 25. The bank examines the documents and finds that the
insurance document was made out for too little. The shipping date is January 15. No
presentation period is mentioned. Will the bank pay the beneficiary? If not, explain your
answer.

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