Purchasing Power Parity and the Fisher Effect
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Eun_9e_International_Financial_Management_PPT_CH201.pptxInternational Trade Finance
Chapter Twenty
Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER 20 provides a brief introduction to trade financing and countertrade. An example of a typical foreign trade transaction explains the three primary documents that are used in trade financing: letter of credit, time draft, and bill of lading.
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Chapter Outline
A Typical Foreign Exchange Transaction
Forfaiting
Government Assistance in Exporting
The Export-Import Bank and Affiliated Organizations
Countertrade
Forms of Countertrade
Some Generalizations about Countertrade
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Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.
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Overview
Virtually impossible for a country to produce domestically everything its citizens need or demand
However, international trade is more difficult and riskier than domestic trade
Exporter may not be familiar with the buyer, and thus may not know if the importer is a good credit risk
Political instability makes it risky to ship merchandise abroad to certain parts of the world
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A Typical Foreign Exchange Transaction
Consider a U.S. importer, who is an automobile dealer, and who desires to purchase automobiles from a Japanese exporter, the manufacturer. The two do not know one another and are obviously separated by a great distance.
If the Japanese manufacturer could have his way, he would have the U.S. importer pay cash in advance for the shipment.
If the auto dealer could have his way, he ideally would prefer to receive the cars on consignment from the auto manufacturer. Second best would be to receive the car shipment on credit and then to make payment.
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In a consignment sale, the exporter retains title to the merchandise that is shipped. The importer only pays the exporter once he sells the merchandise.
The exporter bears all the risk in a consignment sale.
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EXHIBIT 20.1 Process of a Typical Foreign Trade Transaction
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Exhibit 20.1 presents a schematic of the process that is typically followed in foreign trade.
Source: Adapted from Instruments of the Money Market, Federal Reserve Bank of Richmond, 1986.
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Letter of Credit
U.S. importer placing an order with the Japanese exporter, asking if he will ship automobiles under a letter of credit (L/C)
A L/C is a guarantee from the importer’s bank that it will act on behalf of the importer and pay the exporter for the merchandise if all relevant documents specified in the L/C are presented according to terms
U.S. importer will apply to his bank for a letter of credit for the merchandise he desires to purchase, providing his bank with the terms of the sale
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We will now work our way through Exhibit 20.1, presented on the previous slide, in a narrative fashion.
On this slide, we examine steps 1 and 2.
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Time Draft
L/C is sent via the importer’s bank to the exporter’s bank
Once the L/C is received, the exporter’s bank notifies the exporter
Japanese exporter will then ship the cars
After shipping the automobiles, the Japanese exporter will present to his bank a time draft, drawn according to the instructions in the L/C, the bill of lading, and any other shipping documents that are required
A time draft instructs the importer, or his agent, to pay the amount specified on its face on a certain date
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On this slide, we examine steps 1 and 2.
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Bill of Lading
Exporter’s bank presents shipping documents and time draft to the importer’s bank
Bill of lading (B/L) is a document issued by the common carrier specifying that it has received the goods for shipment; it can serve as title to the goods
After taking title to the goods via the bill of lading, the importer’s bank accepts the time draft, creating at this point a banker’s acceptance (B/A), a negotiable money market instrument for which a secondary market exists
Japanese exporter instructs its bank to have the B/A discounted by the importer’s bank
Japanese exporter instructs its bank to pay that amount
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Note that, related to step 8, one of several things can happen with the B/A. Step 8 details the action from Exhibit 20.1.
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Banker’s Acceptance
U.S. importer signs promissory note with his bank for the face value of B/A, due on maturity date of B/A
Importer’s bank provides auto dealer with shipping documents needed to take possession
Importer’s bank sells the B/A in the money market to an investor
B/A sells at a discount from face value
At maturity, importer’s bank will collect the face value of the B/A via the promissory note from U.S. importer
Money market investor presents B/A for payment to the importer’s bank
Importer’s bank pays face value of B/A to the investor
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EXAMPLE 20.1 Cost Analysis of a Banker’s Acceptance
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Forfaiting
Forfaiting is a type of medium-term financing used to finance the sale of capital goods
Involves the sale of promissory notes signed by the importer in favor of the exporter
The forfait, usually a bank, buys the notes at a discount from face value from the exporter
Exporter receives payment and does not have to carry the financing
Began in Switzerland and Germany, but has spread throughout most of Western Europe and into U.S.
Transactions are typically denominated in Swiss francs, euros, and U.S. dollars
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Government Assistance in Exporting
To achieve success in international trade, firms must be competitive in terms of extending credit to importers
Because of the benefits that accrue from exporting, the governments of most developed countries offer competitive assistance to domestic exporters in the form of subsidized credit that can be extended to importers
Credit insurance programs that guarantee financing extended by private financial institutions are common
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The Export-Import Bank and Affiliated Organizations
Export-Import Bank (Ex-Im Bank) of the United States was founded in 1934 and subsequently chartered in 1945, as an independent government agency to facilitate and finance U.S. export trade
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The Export-Import Bank and Affiliated Organizations (Continued)
Ex-Im Bank’s purpose is to provide financing in situations where private financial institutions are unable or unwilling to because:
Loan maturity is too long
Amount of the loan is too large
Loan risk is too great
Importing firm has difficulty obtaining hard currency for payment
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The Export-Import Bank and Affiliated Organizations (Concluded)
Provides service through four major programs:
Working Capital Guarantee Program encourages commercial lenders to make short-term working capital loans to U.S. exporters
Direct Loan Program facilitates direct credit to foreign buyers of U.S. exports
Loan Guarantee Program guarantees the loans made by private FIs to foreign importers
Export Credit Insurance Program protects U.S. exporters against loss should a foreign buyer or other foreign debtor default for political or commercial reasons
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Countertrade
Countertrade is an umbrella term used to describe many different types of transactions, each “in which the seller provides a buyer with goods or services and promises in return to purchase goods or services from the buyer.”
May or may not involve the use of money
Can be traced back to prehistoric times
Used throughout history whenever money was scarce
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Forms of Countertrade
The following forms of countertrade do not involve the use of money:
Barter is the direct exchange of goods between two parties
Clearing arrangement is a form of barter in which the counterparties (governments) contract to purchase a certain amount of goods and services from one another
Switch trade is the purchase by a third party of one country’s clearing agreement imbalance for hard currency, which is in turn resold
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Forms of Countertrade (Continued)
The following forms of countertrade involve the use of money:
A buy-back transaction involves a technology transfer via the sale of a manufacturing plant
A counterpurchase is similar to a buy-back transaction, but with some notable differences
In a counterpurchase, the merchandise the Western seller agrees to purchase is unrelated and has not been produced on the exported equipment
Offset transaction can be viewed as a counterpurchase trade agreement involving the aerospace/defense industry
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Some Generalizations about Countertrade
Negative incentives for a country to be in favor of countertrade:
Conservation of cash and hard currency, improvement of trade imbalances, and the maintenance of export prices
Positive reasons, from both the country and corporate perspectives:
Enhanced economic development, increased employment, technology transfer, market expansion, increased profitability, less costly sourcing of supply, reduction of surplus goods from inventory, and the development of marketing expertise
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Negative incentives are those that are forced upon a country or corporation whether or not it desires to engage in countertrade.
Whether countertrade transactions are good or bad for the global economy, it appears certain that they will increase in the near future as world trade increases.
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