International Business Chapter 19 Financing International Trade Lecture Outline Payment Methods For International Trade Prepayment

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Chapter 19

Financing International Trade

Lecture Outline

Payment Methods for International Trade

Prepayment

Letters of Credit

Drafts

Consignment

Open Account

Impact of the Credit Crisis on Payment Methods

Trade Finance Methods

Accounts Receivable Financing

Factoring

Letters of Credit

Agencies that Facilitate International Trade

Export-Import Bank of the U.S.

Private Export Funding Corporation (PEFCO)

Overseas Private Investment Corporation (OPIC)

Financing International Trade ❖ 2

Chapter Theme

This chapter first suggests why international trade can be difficult. Then, it explains the various ways in

which banking institutions can facilitate international trade by resolving problems faced by the exporter

and importer.

Topics to Stimulate Class Discussion

1. Assume that you receive a call from an old friend who has set up a computer parts store. He says that

he plans to begin exporting these parts soon. What potential complications should he consider?

3. What is the common role of a banking institution in international trade besides financing?

POINT/COUNTER-POINT:

Do Agencies that Facilitate International Trade Prevent Free Trade?

POINT: Yes. The Export-Import Bank of the U.S. provides many programs to help U.S. exporters

conduct international trade. Through its actions, the government essentially subsidizes the exports.

Governments in other countries have various programs as well. Thus, some countries may have a trade

advantage because their exporters are subsidized in various ways. These subsidies distort the notion of

free trade.

COUNTER-POINT: No. It is natural for any government to facilitate exporting for relatively inexperienced

exporting firms. All governments provide a variety of services for their firms, including public services, and

tax breaks for producing products that are ultimately exported. There is a difference between facilitating the

exporting process and versus protecting an industry from foreign competition. The protection of an industry

violates the notion of free trade, but facilitating the exporting process does not.

WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?

Offer your own opinion on this issue.

Answers to End of Chapter Questions

1. Banker’s Acceptances.

a. Describe how foreign trade would be affected if banks did not provide trade-related services.

b. How can a banker’s acceptance be beneficial to an exporter, an importer, and a bank?

Financing International Trade ❖ 3

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ANSWER: Foreign trade would be reduced without the trade-related services by banks, because

some trade can only occur if banks back the transaction with bankers’ acceptances.

A banker’s acceptance guarantees payment to the exporter so that credit risk of the importer is not

worrisome. It allows the importers to import goods without being turned down due to uncertainty

about their credit standing. It is a revenue generator for the bank since a fee is received by the bank

for this service.

2. Export Financing.

a. Why would an exporter provide financing for an importer?

b. Is there much risk in this activity? Explain.

3. Role of Factors. What is the role of a factor in international trade transactions?

4. Export-Import Bank. a) What is the role today of the Export-Import Bank of the U.S.? b) Describe

the Direct Loan Program administered by the Ex-Im Bank.

5. Bills of Lading. What are bills of lading, and how do they facilitate international trade transactions?

6. Forfaiting. What is forfaiting? Specify the type of traded goods for which forfaiting is applied.

7. PEFCO. Briefly describe the role of the Private Export Funding Corporation (PEFCO).

8. Government Programs. This chapter described many forms of government insurance and guarantee

programs. What motivates a government to establish such programs?

Financing International Trade ❖ 4

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ANSWER: Governments may be able to boost exports by establishing policies that either protect the

exporters from various types of risk or encourage lenders to provide financing to the exporters.

9. Countertrade. What is countertrade?

10. Impact of Foreign Exchange Controls. Every quarter, Bronx Co. ships computer chips to a firm in

central Asia. It had not used any trade financing because the importing firm always pays its bill in a

timely manner upon receipt of the computer chips. However, Bronx Co. is concerned that the foreign

government may impose foreign exchange controls. The company reconsiders whether it should use

some form of trade financing that would ensure it is paid for its exports upon delivery. How can

Bronx Co. achieve its goal?

11. Working Capital Loan Guarantee Program. Briefly describe the Working Capital Guarantee

Program administered by the Export-Import Bank.

12. Small Business Policy. Describe the Small Business Policy of the Export-Import Bank.

13. OPIC. Describe the role of the Overseas Private Investment Corporation (OPIC).

Advanced Questions

14. Letters of Credit. Ocean Traders of North America is a firm based in Mobile, Alabama, that specializes

in seafood exports and commonly uses letters of credit (L/Cs) to ensure payment. It recently experienced a

problem, however. Ocean Traders had an irrevocable L/C issued by a Russian bank to ensure that it would

receive payment upon shipment of 16,000 tons of fish to a Russian firm. This bank backed out of its

obligation, however, stating that it was not authorized to guarantee commercial transactions.

a. Explain how an irrevocable L/C would usually facilitate the business transaction between the

Russian importer and Ocean Traders of North America (the U.S. exporter).

Financing International Trade ❖ 5

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

ANSWER: The letter of credit was issued by a Russian bank to guarantee payment for the goods to

be exported by the U.S. exporter.

b. Explain how the cancellation of the L/C could create a trade crisis between the U.S. and Russian

firms.

c. Why do you think situations like this (the cancellation of the L/C) are rare in industrialized

countries?

d. Can you think of any alternative strategy that the U.S. exporter could have used to protect itself

better when dealing with a Russian importer?

ANSWER: The U.S. exporter could have attempted to obtain a letter of credit from a U.S. bank, with

CRITICAL THINKING

Limitations of Payment Methods for International Trade. Write a short essay to provide your

opinion about whether the traditional payment methods for international trade insulate an MNC’s

business when strained relations arise between two countries.

ANSWER

Solution to Continuing Case Problem: Blades, Inc.

1. Assuming that banks in Thailand issue a time draft on behalf of Sports Equipment Inc. and Major

Leagues Inc., would Blades receive payment for its roller blades before it delivers them? Do the

banks issuing the time drafts guarantee payment on behalf of the Thai retailers if they default on the

payment?

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

2. What payment method should Blades suggest to Sports Gear Inc.? Provide support for your answer.

3. What organization could Blades contact in order to insure its sales to the Thai retailers? What type of

insurance do these organizations provide?

4. How could Blades use accounts receivable financing or factoring, considering that it does not

currently have accounts receivable in Thailand? If Blades uses a Thai bank to obtain this financing,

how do you think the fact that Blades does not have receivables in Thailand would affect the terms of

the financing?

ANSWER: Blades could use accounts receivable financing and factoring using its accounts

receivable in the U.S. Using accounts receivable financing, Blades could obtain a loan from a bank

5. Assuming that Blades is unable to locate a Thai bank, that is willing to issue an L/C on its behalf, can

you think of a way Blades could utilize its bank in the U.S. to effectively obtain an L/C from a Thai

bank?

6. What organizations could Blades contact to obtain working capital financing? If Blades is unable to

obtain working capital financing from these organizations, what are its other options to finance its

working capital needs in Thailand?

Financing International Trade ❖ 7

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

loan’s principal and interest. Furthermore, the Overseas Private Investment Corporation (OPIC) will

provide medium- to long-term financing to U.S. investors undertaking an overseas venture.

If Blades is unable to obtain working capital financing from these organizations, it could ask its bank for

a short-term loan that finances the working capital cycle that begins with the purchase of inventory and

continues with the sale of the goods, creation of an account receivable, and conversion to cash.

Solution to Supplemental Case: Ryco Chemical Company

a. Ryco could attempt to work out a countertrade agreement. Ryco could provide chemicals that

Concellos needs in exchange for the chemicals that Ryco normally purchases from Concellos. Ryco

b. Concellos is exposed to the weak currency (called the real). If it purchases the chemicals used in

c. Concellos’ cost of obtaining imports is the cost of producing the chemicals it uses for exchange

(based on the countertrade agreement). Given high inflation in Brazil, these production costs will

Small Business Dilemma

Ensuring Payment for Products Exported by the Sports Exports Company

1. How could Jim use a letter of credit to ensure that he will be paid for the products he exports?

2. Jim has discussed the possibility of expanding his export business through a second sporting goods

distributor in the United Kingdom; this second distributor would cover a different territory than the

first distributor. This second distributor is only willing to engage in a consignment arrangement when

selling footballs to retail stores. Explain the risk to Jim beyond the typical types of risk he incurs

when dealing with the first distributor. Should Jim pursue this type of business?

Financing International Trade ❖ 8

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Also, even if the second distributor does sell the footballs but fails to pay for them, the Sports Exports

Company has limited recourse.

Jim should probably avoid the consignment arrangement because of the risk involved.