BILLS DISCOUNTING M.F.S. CHAPTER – 7 M. Y. KHAN
Bills of Exchange • The bill of exchange (B/E) is used for financing a transaction in goods which means it is essentially a trade related instrument. • According to Negotiable Instruments Act, 1881: “The bills of exchange is an instrument is writing, containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money, only to, or to the order of, a certain person, or to the bearer of that instrument”.
Bills of Exchange: Key Factors • A bill of exchange is…. • An Instrument In Writing • Signed By The Maker • Containing An Unconditional Order Directing A Person • To Pay A Certain Amount Of Money.
Bills of Exchange • BILL OF EXCHANGE IS THE VEHICLE FOR CREDIT TRANSACTIONS IN BUSINESS; IT HAS 3 PARTIES: • DRAWER – WHO MAKES THE BILL/ CREDITOR; • DRAWEE – ON WHOM THE BILL IS DRAWN; • PAYEE -- WHO RECEIVES THE MONEY; • SOMETIMES DRAWER & PAYEE ARE THE SAME PERSON. • ACCEPTANCE TO PAY BY THE DRAWEE IS ESSENTIAL.
Types of Bills • Demand Bill – Payable immediately on presentation/ at sight. • Usance Bill – Time period recognized for payment of bills. • Documentary Bill – These B/E are accompanied by documents that confirm trade has taken place. • Clean Bills – These Bills are not accompanied by any documents. Interest rate charged is higher than documentary bill.
Creation of B/E • Two parties i.e. seller sells goods or merchandise to a buyer. • Seller would like to be paid immediately but buyer would like to pay after sometime. • Seller draws a B/E of a given maturity on the buyer. • Seller (Creditor) becomes drawer of the bill and buyer (Debtor) becomes drawee of the bill. • Seller sends the bill to buyer for his acceptance. • Acceptor may be buyer himself or THIRD PARTY.
Discounting of B/E Holder of an accepted B/E has two options • Hold on the B/E till maturity and then take the payment from the buyer. • Discount the B/E with discounting agency. • The act of handing over an endorsed B/E for ready money is called discounting the B/E. • The margin between the ready money paid and face value of the bill is called the discount.
Contd…. • The maturity of a B/E is defined as the date on which payment falls due. • Normal maturity periods are 30, 60, 90 or 120 days. • Bills maturing within 90 days are most popular. • Discounting agencies are Banks, NBFC and High Net Worth Individuals etc.
Advantages to investors • Short-term source of finance. • Since it is not lending, no tax at source is deducted while making the payment charges which are very convenient. • Flexibility, not only in the quantum of investments but also the duration of investments.
Advantages to Banks • Safety of Funds – B/E is a negotiable instrument bearing the signature of two parties considered good for the amount of bill, so he can enforce his claim easily. • Certainty of Payment – A B/E is a self liquidating asset with the banker knowing in advance the date of its maturity. • Profitability – The discount on bill is front ended, the yield is much higher compare to other loans and advances, where interest paid quarterly or half yearly.
Contd…. • Evens out inter-bank liquidity problem – The B/E has emerged as an instrument of call money market as banks could buy and sell bills to even out their liquidity mismatches.