Chapter 16
International Trade Finance
◼ Learning Objectives
1. Discover the key elements of an import or export business transaction that define the
trade relationship
2. Explore how the three key documents in import/export combine to finance both the
transaction and to manage its risks
3. Describe the variety of government programs to help finance exports
4. Examine the major trade financing alternatives
5. Evaluate the use of a specialized technique, forfaiting, for medium- to long-term trade
financing
◼ Chapter Outline
I. The Trade Relationship
A. Benefits of the System
Protection Against Risk of Noncompletion
Protection Against Foreign Exchange Risk
Financing the Trade
A. Noncompletion Risks
II. Key Documents
B. Letter of Credit (L/C)
Parties to a Letter of Credit (L/C)
Irrevocable Versus Revocable L/C
Confirmed Versus Unconfirmed L/C
Advantages and Disadvantages of L/Cs
C. Draft
Negotiable Instruments
Types of Drafts
Bankers’ Acceptances
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2. Affiliated Buyers. For what reason might an exporter use standard international trade
documentation (letter of credit, draft, order bill of lading) on an intrafirm export to its
parent or sister subsidiary?
3. Related Party Trade. What reasons can you give for the observation that intrafirm trade is
now greater than trade between non-affiliated exporters and importers?
4. Documents. Explain the difference between a letter of credit (L/C) and a draft. How are
they linked?
96 Moffett/Stonehill/Eiteman • Fundamentals of Multinational Finance, Sixth Edition
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A Letter of Credit (L/C) is a document issued by a bank promising to pay if certain
documents are delivered to that bank.
A draft is an order sent to that bank written by a business firm ordering the bank to make
payment. (A personal check is a simple form of a bank draft.) L/Cs and drafts are linked
because the L/C states the conditions under which the bank promises to honor a draft
drawn on (e.g., directed to) that bank.
5. Risks. What is the major difference between “currency risk” and “risk of noncompletion?”
How are these risks handled in a typical international trade transaction?
6. Letter of Credit. Identify each party to a letter of credit (L/C) and indicate its responsibility.
7. Confirmed Letter of Credit. Why would an exporter insist on a confirmed letter of credit?
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8. Documenting an Export of Hard Drives. List the steps involved in the export of computer
hard disk drives from Penang, Malaysia, to San Jose, California, using an unconfirmed letter
of credit authorizing payment on sight.
9. Documenting an Export of Lumber from Portland to Yokohama. List the steps involved
in the export of lumber from Portland, Oregon, to Yokohama, Japan, using a confirmed
letter of credit, payment to be made in 120 days.
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10. Governmentally Supplied Credit. Various governments have established agencies to
insure against nonpayment for exports and/or to provide export credit. This shifts credit
risk away from private banks and to the citizen taxpayers of the country whose
government created and backs the agency. Why would such an arrangement be of benefit
to the citizens of that country?
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