CHP 16

Multinational Business Finance
Fifteenth Edition, Global Edition
Chapter 16
International Trade Finance
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Learning Objectives
16.1 Discover the key elements of an import or export
business transaction that define the trade relationship
16.2 Explore how the three key documents in import/export
combine to finance both the transaction and to manage its
risks
16.3 Describe the variety of government programs to help
finance exports
16.4 Examine the major trade financing alternatives
16.5 Evaluate the use of a specialized technique, forfaiting,
for medium- to long-term trade financing

The Trade Relationship (1 of 4)
• Trade financing shares a number of common characteristics with the
traditional value chain activities conducted by all firms.
• All companies must search out suppliers for the many goods and
services required as inputs to their own goods production or service
provision processes.
• Issues to consider in this process include the capability of suppliers
to produce the product to adequate specifications, deliver said
products in a timely fashion, and to work in conjunction on product
enhancements and continuous process improvement.
• All of the above must also be at an acceptable price and payment
terms.
• Exhibit 16.1 demonstrates the flow of goods and funds.

Exhibit 16.1 Financing Trade: The
Flow of Goods and Funds
For long description, see slide 32: Appendix 1

• The nature of the relationship between the exporter and
the importer is critical to understanding the methods for
import-export financing utilized in industry (see Exhibit
16.2):
– Unaffiliated unknown
– Unaffiliated known
– Affiliated (sometimes referred to as intra-firm trade)
• The composition of global trade has changed dramatically
over the past few decades, moving from transactions
between unaffiliated parties to affiliated transactions.

Exhibit 16.2 Alternative International
Trade Relationships

• International trade must work around a fundamental
dilemma:
– They live far apart
– They speak different languages
– They operate in different political environments
– They have different religions
– They have different standards for honoring obligations
• In essence, there could be distrust, and clearly the
importer and exporter would prefer two different
arrangements for payment/goods transfer (Exhibit 16.3).

Exhibit 16.3 The Mechanics of
Import and Export

• The fundamental dilemma of being unwilling to trust a
stranger in a foreign land is solved by using a highly
respected bank as an intermediary.
• Exhibit 16.4 is a simplified view involving a letter of credit
(a bank’s promise to pay) on behalf of the importer.
• Two other significant documents are an order bill of
lading and a sight draft.

Exhibit 16.4 The Bank as the
Import/Export Intermediary

Benefits of the System
• The system (including the three documents discussed)
has been developed and modified over centuries to
protect both importer and exporter from:
– The risk of noncompletion
– Foreign exchange risk
– To provide a means of financing

Noncompletion Risks
• Exhibit 16.5 illustrates the sequence of events in a single
export transaction.
• From a financial management perspective, the two
primary risks associated with an international trade
transaction are currency risk (currency denomination of
payment) and risk of noncompletion (timely and complete
payment).
• The risk of default on the part of the importer is present
as soon as the financing period begins.

Exhibit 16.5 The Trade Transaction
Time Line and Structure

Key Documents: Letter of Credit
(L/C) (1 of 3)
• A letter of credit (L/C) is a bank’s conditional promise to
pay issued by a bank at the request of an importer, in
which the bank promises to pay an exporter upon
presentation of documents specified in the L/C.
• An L/C reduces the risk of noncompletion because the
bank agrees to pay against documents rather than actual
merchandise.
• Exhibit 16.6 shows the relationship between the three
parties.

Exhibit 16.6 Parties to a Letter of
Credit (L/C)

(L/C) (2 of 3)
• The essence of an L/C is the promise of the issuing bank
to pay against specified documents, which must
accompany any draft drawn against the credit.
• The L/C is not a guarantee of the underlying commercial
transaction, but rather a separate transaction from any
sales or other contracts on which it might be based.

(L/C) (3 of 3)
• Commercial letters of credit are also classified as follows:
– Irrevocable versus revocable
– Confirmed versus unconfirmed
• The primary advantage of an L/C is that it reduces risk—
the exporter can sell against a bank’s promise to pay
rather than against the promise of a commercial firm.
• The major advantage of an L/C to an importer is that the
importer need not pay out funds until the documents have
arrived at the bank that issued the L/C and after all
conditions stated in the credit have been fulfilled.
• The essence of an L/C is shown in Exhibit 16.7.
Exhibit 16.7 Essence of a Letter of
Credit (L/C)

Key Documents: Draft (1 of 2)
• A draft, sometimes called a bill of exchange (B/E), is the
instrument normally used in international commerce to effect
payment.
• A draft is simply an order written by an exporter (seller)
instructing an importer (buyer) or its agent to pay a specified
amount of money at a specified time.
• The person or business initiating the draft is known as the
maker, drawer, or originator.
• Normally this is the exporter who sells and ships the
merchandise.
• The party to whom the draft is addressed is the drawee.

Key Documents: Draft (2 of 2)
• If properly drawn, drafts can become negotiable instruments.
• As such, they provide a convenient instrument for financing the international

movement of merchandise (freely bought and sold).
• To become a negotiable instrument, a draft must conform to the following
four requirements:
– It must be in writing and signed by the maker or drawer
– It must contain an unconditional promise or order to pay a definite sum
of money
– It must be payable on demand or at a fixed or determinable future date
– It must be payable to order or to bearer
• A draft accepted by a bank becomes a banker’s acceptance
• There are time drafts and sight drafts.

Key Documents: Bill of Lading (B/L)
• The third key document for financing international trade is
the bill of lading or B/L.
• The bill of lading is issued to the exporter by a common
carrier transporting the merchandise.
• It serves three purposes:
– Receipt
– Contract
– Document of title
• Bills of lading are either straight or to order.

Documentation in a Typical Trade
Transaction
• A trade transaction could conceivably be handled in many
ways.
• The transaction that would best illustrate the interactions
of the various documents would be an export financed
under a documentary commercial letter of credit,
requiring an order bill of lading, with the exporter
collecting via a time draft accepted by the importer’s
bank.
• Exhibit 16.8 illustrates such a transaction.

Exhibit 16.8 Steps in a Typical Trade
Transaction

Government Programs to Help
Finance Exports (1 of 2)
• Governments of most export-oriented industrialized countries
have special financial institutions that provide some form of
subsidized credit to their own national exporters.
• These export finance institutions offer terms that are better
than those generally available from the competitive private
sector.
• Thus, domestic taxpayers are subsidizing lower financial costs
for foreign buyers in order to create employment and maintain
a technological edge.
• The most important institutions usually offer export credit
insurance and a government-supported bank for export
financing.
Government Programs to Help
Finance Exports (2 of 2)
• The exporter who insists on cash or L/C payment for foreign
shipments is likely to lose orders to competitors from other countries
that provide more favorable credit terms.
• Competition between nations to increase exports by lengthening the
period for which credit transactions can be insured may lead to a
credit war and to unsound credit decisions.
• In the United States, export credit insurance is provided by the
Foreign Credit Insurance Association (FCIA), an unincorporated
association of private commercial insurance companies operating in
cooperation with the Export-Import Bank.
• The Export-Import Bank of the U.S. (Eximbank) is another important
agency of the U.S. Government established to facilitate the foreign
trade of the United States.
Trade Financing Alternatives (1 of 2)
• In order to finance international trade receivables, firms
use the same financing instruments as they use for
domestic trade receivables, plus a few specialized
instruments that are only available for financing
international trade.
• There are short-term financing instruments and longer-
term instruments in addition to the use of various types of
barter to substitute for these instruments.

Trade Financing Alternatives (2 of 2)
• Some of the shorter term financing instruments include
(see Exhibit 16.9):
– Bankers Acceptances
– Trade Acceptances
– Factoring
– Securitization
– Bank Credit Lines
– Commercial Paper

Exhibit 16.9 Instruments for Financing Short-
Term Domestic and International Trade
Receivables
Instrument Cost or Yield for 3-Month Maturity
Bankers’ acceptances* 1.14% yield annualized
Trade acceptances* 1.17% yield annualized
Factoring Variable rate but much higher cost than bank credit
lines
Securitization Variable rate but competitive with bank credit lines
Bank credit lines LIBOR or Prime plus points (fewer points if covered
by export credit insurance)
Commercial paper* 1.15% yield annualized
* These instruments compete with 3-month marketable bank time

certificates of deposit that yield 1.17%.

Forfaiting
• Forfaiting is a longer term financing instrument used to
eliminate the risk of nonpayment by importers in instances
where the importing firm and/or its government is perceived by
the exporter to be too risky for open account credit.
• A typical forfaiting transaction involves five parties—importer,
exporter, forfaiter, investor, and the importers bank (see Exhibit
16.10).
• The essence of forfaiting is the non-recourse sale by an
exporter of bank-guaranteed promissory notes, bills of
exchange, or similar documents received from an importer in
another country.

Exhibit 16.10 Typical Forfaiting
Transaction

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Appendix 1
Long Description for a diagram represents the flow of
goods and funds between Aidan Ireland in Dublin and its
suppliers and buyers.
Aidan Ireland receives components from domestic
suppliers in Ireland and foreign suppliers in Oslo, Norway.
Aidan Ireland pays euros to the domestic suppliers, and it
pays Norwegian krone to the Norwegian suppliers. Aidan
Ireland sells products to domestic buyers in Ireland and
foreign buyers in Reykjavík, Iceland. The domestic buyers
pay in euros, and the Icelandic buyers pay in Icelandic
krona.
Return to presentation
Appendix 2
Long Description for a diagram represents Aidan’s trade relationships with
affiliated and unaffiliated parties.
Aidan’s relationships with importers have different requirements depending on

whether or not the importer is an unaffiliated unknown party, an unaffiliated
known party, or an affiliated party. The following list describes the requirements
for each type of importer.
• An unaffiliated unknown party is a new customer with which Aidan has no
historical business relationship. This relationship requires a contract and
protection against nonpayment.
• An unaffiliated known party is a long term customer with which there is an
established relationship of trust and performance. This relationship requires
a contract and possibly some protection against nonpayment.
• An affiliated party is a foreign subsidiary or business unit of Aidan. This
relationship requires no contract and may or may not require protection.
Appendix 3
Long Description for a diagram represents the mechanics
of import and export, depending on importer and exporter
preference.
The import and export process depends on importer and
exporter preference. In a system based on importer
preference, the exporter ships the goods, and the importer
pays after the goods are received. In a system based on
exporter preference, the importer pays for the goods, and
the exporter ships the goods after being paid.
Appendix 4
Long Description for a diagram represents the 6 step import and export
process, using a bank as an intermediary.
The import and export process has 6 steps described in the following list.
• Step 1. The importer obtains the bank’s promise to pay on importer’s behalf.
• Step 2. The bank promises the exporter to pay on behalf of the importer.
• Step 3. The exporter ships quote to the bank end quote trusting the bank’s
promise.
• Step 4. The bank pays the exporter.
• Step 5. The bank quote gives end quote merchandise to the importer.
• Step 6. The importer pays the bank.
Appendix 5
Long Description for a timeline represents trade transactions and structure.
The timeline provides events and periods involved with trade transactions, as described in
the following list.
• First event, price quote request
• Second event, export contract signed
• The negotiations period is between the price quote request and the signing of the export
contract.
• Third event, goods are shipped, and documents are presented
• The backlog period is between the signing of the export contract and the shipping of
goods
• Fourth event, documents are accepted
• Fifth event, goods are received
• Sixth event, cash settlement of the transaction
• The financing period is between the presentation of the documents and the cash
settlement.
Appendix 6
Long Description for a diagram represents the relationships between the
three parties to a letter of credit.
The three parties to a letter of credit are the issuing bank, the applicant or
importer, and the beneficiary or exporter. The following list provides the
relationships between the parties.
• the relationship between the importer and the issuing bank is governed
by the terms of the application and the agreement for the letter of credit
or, l c.
• The relationship between the issuing bank and the exporter is governed
by the terms of the letter of credit, as issued by that bank.
• The relationship between the importer and the exporter is governed by
the sales contract.
Appendix 7
Long Description for a summarized sample irrevocable Letter of Credit
drawn against Bank of the East, Limited.
The sample letter reads, Bank of the East, Limited. left bracket, name of
issuing bank, right bracket. Date, September 18, 2011. L slash C Number
1 2 3 4 5 6. Bank of the East, limited, hereby issues this irrevocable
documentary Letter of Credit to Jones Company left bracket, name of
exporter, right bracket, for 500,000 U S Dollars, payable 90 days after
sight by a draft drawn against Bank of the East, limited, in accordance
with Letter of Credit number 1 2 3 4 5 6. This draft is to be accompanied
by the following documents. 1. Commercial invoice in triplicate. 2. Packing
list. 3. Clean on board order bill of lading. 4. Insurance documents, paid
for by buyer. At maturity, Bank of the East, Limited, will pay the face
amount of the draft to the bearer of that draft. Authorized Signature.
Appendix 8
Long Description for a diagram represents the steps in a typical trade transaction.
The typical trade transaction involves 14 steps, as described in the following list.
• Step 1. The importer orders goods.
• Step 2. The exporter agrees to fill the order.
• Step 3. The importer arranges the letter of credit with its bank.
• Step 4. Aspen Bank sends the letter of credit to Corylus Bank.
• Step 5. Corylus Bank advises the exporter of the letter of credit.
• Step 6. The exporter ships goods to the importer.
• Step 7. The exporter presents draft and documents to its bank, Corylus Bank.
• Step 8. Corylus Bank presents draft and documents to Aspen Bank.
• Step 9. Aspen Bank accepts draft, promising to pay in 60 days, and returns the accepted draft to Corylus Bank.
• Step 10. Corylus Bank sells acceptance to the investor.
• Step 11. Corylus Bank pays the exporter.
• Step 12. Aspen Bank obtains the importer’s note and releases the shipment.
• Step 13. The importer pays the bank.
• Step 14. The investor presents acceptance and is paid by Aspen Bank.
Appendix 9
Long Description for a diagram represents a typical forfaiting transaction.
The typical forfaiting transaction has 7 steps, as described in the following list.
• Step 1. The exporter from the private industrial firm interacts with the importer from a
private firm or government purchaser in an emerging market.
• Step 2. The exporter interacts with the forfeiter, which is a subsidiary of a European bank.
• Step 3. The importer contacts the importer’s bank, which is usually a private bank in the
importer’s country.
• Step 4. The importer’s bank contacts the exporter.
• Step 5. The exporter contacts the forfeiter.
• Step 6. The forfeiter contacts the institutional or individual investor.
• Step 7. The investor interacts with the importer’s bank.

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Multinational Business Finance

Fifteenth Edition, Global Edition

Slides in this presentation contain hyperlinks.

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 32: Appendix 1

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 33: Appendix 2

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 34: Appendix 3

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 35: Appendix 4

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 36: Appendix 5

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 37: Appendix 6

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 38: Appendix 7

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

• As such, they provide a convenient instrument for financing the international

• A draft accepted by a bank becomes a banker’s acceptance

• There are time drafts and sight drafts.

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 39: Appendix 8

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

* These instruments compete with 3-month marketable bank time

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

For long description, see slide 40: Appendix 9

This work is protected by United States copyright laws and is

Copyright © 2021 Pearson Education Ltd. All Rights Reserved

Aidan’s relationships with importers have different requirements depending on

• Step 6. The importer pays the bank.

• Step 4. The importer’s bank contacts the exporter.

• Step 5. The exporter contacts the forfeiter.

• Step 6. The forfeiter contacts the institutional or individual investor.

• Step 7. The investor interacts with the importer’s bank.

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