International Trade Payment Methods

1. International Trade Payment Methods ASBDC Conference September 8, 2011

2. Understanding International Financial Risk • Commercial • Sovereign or Political • Foreign Exchange

3. Movement of Funds • SWIFT • Society for Worldwide Interbank Financial Telecommunication • Drafts • Bank • Sight • Usance • Checks

4. Foreign Exchange

5. Foreign Exchange • An exchange of one currency for another currency • (i.e.) Dollars (USD) for Japanese Yen (JPY) • Indirect Quote (European) • 1 USD = 77.0599 JPY • Direct Quote (American) • 1 JPY = .0129769 USD

6. Who uses Foreign Exchange • Tourists • Importers / Exporters • Investors • Speculators • Central Banks

7. Local Currency Payment Western Europe Japan, Hong Kong, Singapore, Australia and New Zealand Canada, Mexico South Africa Thailand, Indonesia US$ Payment South America Eastern Europe China, Taiwan Africa Malaysia Which Currencies are Traded

8. Instruments most commonly used to offset risk • Spot • Forwards (up to 1 year typically) • Futures • Swaps • Options

9. Determinants of Spot Rate • Balance of Payments/Trade • Real rates of return • Current growth and growth prospects of the economy • Economic and political stability • Exchange restrictions, if any • Central Bank intervention

10. Forward Contracts • Purchase or sale of one currency for another with delivery taking place on a specific future date or within a specific window of time • Unlike futures traded over-the-counter • Any convertible currency • Any maturity (typically less than a year) • Any amount (typically with a $50,000 min)

11. Forward Contracts • Price is based on: • Current spot rate plus or minus a discount or premium for interest rate differentials • Determinants of Forward Rates • A currency is at a PREMIUM against another currency in the forward market when that other currency’s interest rate is higher • A currency is at a DISCOUNT against another currency in the forward market when that other currency’s interest rate is lower

12. Options • The right but not the obligation to convert one currency for another on a specific future date. • Price is based on: • current spot price • strike price • volatility factor • Example: • The right to buy Japanese Yen at a specific rate one year out in the future. If the Yen weakens a conversion will be made in the open market.

13. Forward Contract Eliminates up and downside potential Good tool when company has firm commitments in the future Mark-to-market offset against A/R or A/P No initial cost 10% risk assessment Option Eliminates “downside” but leaves “upside” Good tool for company involved in projects with uncertainty “Naked hedge” for commitments not yet recognized on the balance sheet 1-5% premium up front a tough sale Options vs Forward Contract

14. Futures Contracts • Contracts for specific quantities of a given currency • Chicago Mercantile Exchange • Exchange rate fixed at time contract is entered into • Mark to Market • Daily settlement with profits or losses paid every day

15. Advantages Smaller size Freedom to liquidate a contract anytime Disadvantages Limited number of currencies Limited delivery dates Rigid contractual amounts Futures versus Forwards

16. Foreign Exchange Objectives • Maximize consolidated net after-tax cash flows without undue risk • Preserve US dollar value of cash flow • Minimize volatility in reported earnings • Maximize profitability

17. Payment Methods

18. International Payment Methods • Cash in Advance • Open Account • Documentary Collections • Letters of Credit

19. Risk vs. Method of Payment Buyer Risk Seller Risk • Open Account • Documentary Collection • Letter of Credit • Cash in Advance Low High High Low

20. Cash In Advance • Time of Payment • Before Shipment • Goods Available to Buyer • After Payment • Risks to Seller • None • When Appropriate • Seller has negotiating strength to demand cash in advance

21. Open Account • Time of Payment • As agreed; i.e. 30 days • Goods Available to Buyer • Before Payment • Risks to Seller • Buyer defaults on payment obligation • Delays in availability of foreign exchange and transferring of funds from buyer’s country

22. Open Account • When Appropriate • Seller has absolute trust that buyer will accept shipment and pay at agreed time • Seller is confident that importing country will not impose regulations deferring or blocking transfer of payment • Seller has sufficient liquidity or access to outside financing to extend deferred payment terms

23. Benefits of Export Credit Insurance • Risk Mitigation • Political • Commercial • Market Penetration • Extended credit terms to foreign buyers • Relaxation of method of payment reducing bank costs and documentation • Financing • U.S. exporter can borrow against insured foreign receivables

24. Documentary Collection Characteristics • Allows exporters to retain ownership of the goods until they receive payment or are reasonably certain they will receive it • Bank acts as agent for exporter by holding the title documents • Bank assumes no risk but must act in good faith and exercise reasonable care

25. Documentary Collection Seller Buyer $ $ Documents Documents Documents $ Buyer’s Bank Seller’s Bank

26. Draft or Bill of Exchange ______________________________________ ________________________________ NO.___________ (CITY) (DATE) AT _____________________________________________________ SIGHT OF THIS BILL OF EXCHANGE PAY TO THE ORDER OF ________________________________________ ___________________ (AMOUNT IN FIGURES) THE SUM OF___________________________________________________________________________ ______________________________________________________________________________________ TO ________________________________________ ______________________________________ DRAWER _________________________________________ _________________________________________ ______________________________________ DRAWEE BY: AUTHORIZED SIGNATURE

27. Documentary Collection - D/P • Time of Payment • On presentation of sight draft by a bank to buyer • Goods Available to Buyer • After payment • Risks to Seller • Buyer’s nonacceptance of shipment • Payment delays due to unavailability of foreign exchange in buyer’s country • Payment blocked due to political actions in buyer’s country

28. Documentary Collection - D/P • When Appropriate • Seller is confident that buyer will accept shipment • Seller is confident that importing country will not impose regulations deferring or blocking transfer of payment

29. Documentary Collections - D/A • Time of Payment • At maturity of accepted draft • Goods Available to Buyer • Before payment • Risks to Seller • Buyer’s default on payment obligation • Delays in availability of foreign exchange and transferring of funds from buyer’s country • Payment blocked due to political events in buyer’s country

30. Documentary Collections - D/A • When Appropriate • Seller has confidence that buyer will accept shipment and pay on agreed date • Seller is confident that importing country will not impose regulations deferring or blocking the transfer of payment

31. Documentary Collections Risk • Unscrupulous buyer • Insolvent buyer • Buyer changes mind • Buyer’s country is in turmoil • Foreign exchange may not be available • Seller may have to pay return freight • Buyer may not honor promise to pay

32. Letter of Credit • Letters of Credit (L/Cs) are legal instrumentsissued by banks (on behalf of their customers) with the conditional obligation to make payment to the beneficiary of the L/C • Documentary (Trade) Letters of Credit are used to facilitate payments in import and export transactions • Standby Letters of Credit are “Standing By” for an event of default or non-performance before they can be drawn on

33. Advising Bank authenticates LC Confirming Bank guarantees payment if Issuing Bank defaults Applicant Buyer/Importer Beneficiary Seller/Exporter Issuing Bank Guarantees payment Letter of Credit – Key Parties

34. Irrevocable ICC UCP 600 ISP 98 Incoterms Tenor Sight Usance Discrepancies L/C Terminology

35. Uniform Customs and Practices for Documentary CreditsThe U.C.P. 600 (2007 Revision) • General provisions and definitions. • Form and notification of credits. • Liabilities and responsibilities of parties. • Documents of commerce. • Miscellaneous provisions. • Transferability of letters of credit.

36. Commonly Used Documents • Commercial Invoice • Transport Document • Ocean Bill of Lading • Air Waybill • Packing Lists/Weight Lists • Insurance Policy or Certificate • Draft or Bill of Exchange • Other Documents • Inspection Certificate • Special Customs Invoices • Certificate of Origin

37. Draft or Bill of Exchange ______________________________________ ________________________________ NO.___________ (CITY) (DATE) AT _____________________________________________________ SIGHT OF THIS BILL OF EXCHANGE PAY TO THE ORDER OF ________________________________________ ___________________ (AMOUNT IN FIGURES) THE SUM OF___________________________________________________________________________ ______________________________________________________________________________________ DRAWN UNDER ________________________________________________________________________ LC NO. ________________ DATED __________ TO ________________________________________ ______________________________________ DRAWER _________________________________________ _________________________________________ ______________________________________ DRAWEE BY: AUTHORIZED SIGNATURE

38. Letter of Credit Issuance Contract Exporter Step 1 Importer Step 4 L/C Forwarded to Beneficiary with or without confirmation Application Made for Letter of Credit Step 2 Letter of Credit Forwarded by the Issuing Bank Issuing Bank in Importer’s City Advising Bank in Exporter’s City Step 3

39. Letter of Credit Payment Step 3 Documents Issuing / Opening Bank Advising/ Confirming Bank Step 4 Step 2 Money Documents Money Documents Money Buyer Importer Account Party Seller/ Exporter Beneficiary Step 5 Step 1 Surrenders Bill of Lading Receives Goods Receives Bill of Lading Surrenders Goods Carrier

40. Letter of Credit • Time of Payment • When LC calls for a sight draft - at time documents are presented to negotiating bank • When LC calls for a time (usance) draft - at maturity of accepted time draft • Goods Available to Buyer • When LC calls for a sight draft - after payment • When LC calls for a time draft - after draft has been accepted by bank

41. Letter of Credit • Risks to Seller • Discrepancies in the documents • Buyer’s Bank (opening bank) defaults on its payment obligation • Payment blocked due to political events in buyer’s country • When Appropriate • Seller is unsure of creditworthiness of buyer

42. Letter of Credit Variations • Back to Back • Assignment of Proceeds • Transferable • Revolving • Standby

43. Standby Letter of Credit • Commercial documents generally flow outside the letter of credit (between buyer and seller). • Funds generally flow outside of a letter of credit (between buyer and seller). • These credits are “Standing By” for an event of default or non-performance before they can be drawn on.

44. Standby Letter of Credit Financial Assures account party’s performance of a financial obligation, i.e., to pay an invoice by a certain date. Performance Assures account party’s performance of a non-financial contract obligation, i.e., to deliver products under a contract.

45. Factors to Consider in Determining Payment Terms Under a Contract

46. Other Financing Options • Countertrade • i.e. barter, counterpurchase, compensation • Factoring • Outright sale of short term receivables • Forfaiting • Outright sale of medium term (large) obligation

47. International Trade Payment Methods Cassie Stiles cassstiles@yahoo.com