ACF 465 INTERNATIONAL TRADE FINANCE 2017.pdf

An intro to trade finance and it's relevance to international marketing

1. ACF 465:
August 2017
INTERNATIONAL TRADE FINANCE
Mr. Kwasi Poku
[email protected] // 0207401585

2. Course Overview
•
•
The aim of this course is to help students acquire the necessary
background information and also gain an understanding of the finance of
international trade, foreign exchange and support services provided for
exporters, importers and merchants by financial institutions especially in
Ghana.
 
This course also seeks to help students acquire a sound understanding of
relevant theoretical and practical concepts, coupled with an ability to
apply the principles in a given practical situation.
 
 
2

3. 3
•
•
Students should however note that, international trade is a rapidly
changing subject, hence careful study of publications and newspapers such
as graphic business, business and financial times and the various customer
leaflets and circulars prepared by banks is essential in order to keep up to
date.
 
 
In addition, students should regularly search the internet to keep abreast of
new developments.

4. Course Objectives
•
•
To help students to appreciate the need for international trade, the
risks and problems encountered in international trade and the role
played by banks in facilitating international trade.
 
 
To help students gain an understanding of the various terms of
payment in international trade.
4

5. •
•
To help students to be able to define the various terminologies
developed by the International Chamber of Commerce (ICC) to be used
in international trade. It also aims to help students appreciate the
obligations and responsibilities that Incoterms impose on importers and
exporters.
 
To help students to be able to explain the various international
settlement mechanisms through banks and the problems encountered in
international settlements.

5

6. •
•
•
To help students gain an understanding of letters of credit, the parties
involved in issuing letters of credit as well as the general instructions to be
followed before banks issue letters of credit.
 
To help students appreciate the relevance of documentation in international
trade.
 
To help students gain an understanding of the factors which affect export
finance as well as the traditional and non­traditional facilities provided by
banks to facilitate export trade.

6

7. •
•
•
To help students to appreciate the types of credit available to importers
in Ghana.
 
To help students gain an understanding of the various facilities and
services provided by banks to new exporters and the travelling public.
 
To help students to appreciate the basic operations of the foreign
exchange market in Ghana and the factors that affect the demand and
supply for foreign exchange in Ghana.
 

7

8. Course Outline
•
•
•
•
•
Unit 1:  OVERVIEW OF INTERNATIONAL TRADE FINANCE
Unit 2:  METHODS OF PAYMENT IN INTERNATIONAL TRADE
Unit 3:  INCOTERMS/TERMS OF DELIVERY/SHIPPING TERMS
Unit 4: DOCUMENTS USED IN INTERNATIONAL TRADE
Unit 5: DOCUMENTARY CREDIT
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9. Course Outline
•
•
•
•
Unit 6: OVERVIEW OF EXPORT FINANCE
Unit 7: IMPORT FINANCING
Unit 8: METHODS OF INTERNATIONAL SETTLEMENT
THROUGH BANKS
Unit 9: FOREIGN EXCHANGE MARKETS

9

10. Grading
•
•
Continuous assessment: 30%
End of semester examination: 70%
 
10

11. Recommended Reading
•
•
•
Arnold, G. (2008). Corporate Financial Management. 4
th
 Edition.
Financial Times/Pearson Education Ltd
 
Atuahene, R. (2016). Finance of International Trade­Chartered Institute
of Bankers (GH), 2
nd
 Edition.
 
Cowdell, P. and Hyde, D (2003). International Trade Finance­The
Institute of Financial Services (UK), 8
th
 Edition.

11

12. •
•
•
Cranston, R. (2007). Principles of Banking Law. 2
nd
 Edition. Oxford
University Press, UK.
 
Luke, K.W. (2015). International Trade Finance: A Practical Guide. 2
nd
Edition. City University of Hong Kong Press.
 
Watson, D. and Head, A. (2010). Corporate Finance: Principles and
Practice. 5
th
 Edition. Financial Times/Prentice Hall.

12

13. UNIT 1:
OVERVIEW OF INTERNATIONAL TRADE
•
•
•
•
•
Objectives;
To discuss the need for International Trade
 To discuss the Problems/Difficulties of International Trade
 To explain the difference between International and Domestic Trade
 To discuss the theories of International Trade
 To know the major players in International Trade
 
 
 

14. •
•
•
•
To examine the objectives of the parties in International Trade
 To help students appreciate the risks in International Trade
 To explain International Trade Fraud and Trade Based Money
Laundering
 To understand & appreciate the role of Banks in International Trade
system
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15. Introduction
•
•
Definition of International Trade:
International Trade is the process of buying and selling
between two parties in two different countries where
business activity calls for payment or settlement in a
foreign currency. Trading can be conducted for both
goods and services.
 
International can be categorised into visible trade­ the
export and import of goods, and invisible trade­ the use of
services from other countries.

16. Why Companies Expand Into Foreign Markets
•
•
•
The complexities in International Trade require imaginative and proactive
strategies.
 
It is therefore very vital that companies receive quality advice from expert
sources to help them make informed business decisions on international
trade business.

Companies opt to expand outside their domestic market for any of four
major reasons:
 

17. 1.
•
•
To Gain Access To New Customers
Expanding into foreign markets offers potential for increased
revenues, profits, and long­term growth and becomes an
especially attractive option when a company’s home markets are
matured or saturated.
 
Firms like the Ghana Cocoa Board Ltd, Sony, Toyota, Mercedes
Benz and General Motors, which are racing for global
leadership in their respective industries must move rapidly and
aggressively to extend their market reach to all corners of the
world.
 

17

18. •
•
2. To Achieve Lower Costs And Enhance The Firm’s
Competitiveness
Many companies are driven to sell in more than one country
because the sales volume achieved in their domestic markets is
not large enough to fully capture manufacturing economies of
scale and experience curve effects and thereby substantially
improve a firm’s cost competitiveness.
 
The relative small size of country markets in Europe explains
why companies like Nestle sell their products all across Europe
and then moved into markets in North America, Africa and
Latin America.

19. •


•
Also, some companies abroad may have a competitive advantage in the
provision of certain goods and services.
The need to earn more profit by selling goods or services in overseas
markets.
Some firms act as export houses or import merchants. Bamson Company
ltd.
 
 
In Ghana, is an importer of Dutch Akzo paints. Thus, acting as a
middleman between buyer and seller in different countries.

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20. •
•
•
3. To Capitalize On Its Core Competencies
A company with competitively valuable competencies and capabilities may be
able to leverage on them into a position of competitive advantage in foreign
markets as well as just domestic markets.
 
4. To spread its business risk across a wider market base
A company spreads business risk by operating in a number of different
foreign countries rather than depending entirely on its operations in its own
domestic market.
 
Globalization and improved technologies equally offer immense opportunities
for firms to benefit from economies of scale and tax advantages.
 

21. •In a few cases, companies in natural resource­based industries
often find it necessary to operate in the international arena because
attractive raw materials supplies are located in foreign countries.

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22. Differences Between International Trade and Domestic Trade




•
a)
b)
c)
d)
e)
f)
Domestic trade has the following features which are common for both
seller and buyer but differ entirely from that of international trade:
 
A single currency is the mode of payment;
Trading is conducted under the same law;
 Documentation to the domestic trade is very simple;
Business is done in the absence of stringent Customs Excise and
Preventive Regulations;
No or little transportation difficulties are encountered;
Most businesses are conducted under common language and culture;
 

23. Inherent Problems / Difficulties In International Trade
•
1.
•
Aside the normal problems of trade and commerce which arise in the
domestic trade, there are several additional difficulties associated with
international Trade.
 
   Some of the problems are:
Time and distance
The time lag between placing an order from suppliers could affect trade
through changes in changes in pricing, additional working capital
requirement on the part of the supplier, non­payment on the part of the
buyer, changes in customer’s taste, substitute product and non­delivery
time lag.
 

24. •
•
Differences in time zone also results in communication difficulties.
 
Distance also affects international trade when the risks and
inconveniences, in relation to transit times, cannot be avoided
considering the time it takes to ship goods and services abroad and the
time payment is received.

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25. •
•
2. Differences in laws/customs
Lack of knowledge and understanding about customs, habits and laws of
the buyer’s or the seller’s country create an extra degree of uncertainty or
mistrust between the two parties involved in trade. e.g. exporting pork to
a Moslem country.
 
3. Documentation
The nature of the trade, transportation requirement, mode of payment and
terms of delivery used in the trade call for a comprehensive and thorough
understanding of the documents which makes international trade more
complicated than in domestic trade.
 
 

26. •
a)
b)
c)
d)
e)
f)
g)
4. Government regulations
Government rules and restrictions can be a serious threat to international trade.
Such regulations and restrictions include:
 Exchange control regulations
 Export licensing
 Import licensing
 Trade Embargoes
 Import quotas
 Health and hygiene requirements, notably on food
 Patent and trademarks
 

27. •
•
i.
ii.
iii.
Exchange control regulation
Exchange control is system of controlling the inflows and the outflows of
foreign exchange in and out of a country.
Government may therefore take extra measures in defense of its currency, such
as;
Regulations requiring individuals or firms to obtain foreign exchange approval
from the Central Bank before engaging international trade activities.
 
Regulations rationing the supply of foreign exchange to those wishing to
make payment abroad in a foreign currency.
 
Regulations making the holding of foreign currency or exchange illegal by
legislation.
 
 

28. Principal Players In International Trade
a)
•
•
•
Exporters
Exporters may be manufacturers, traders, farmers or commodity producers.
 
Their aim is to get their goods to buyers around the world in the quickest
and safest manner possible and to be paid in the correct currency and
within their agreed terms of settlement.
 
The importance of exports to the economies of many countries is
demonstrated by the wide range of support and encouragement given by
governments, particularly through Export Credit Agencies.
 
 

29. •
•
•
b) Importers
Importers may be equally be manufacturers buying raw materials for their
factories, oil companies buying crude oil for refining, or simply merchants
and traders fulfilling contracts with domestic and foreign consumers.
 
c) Freight Forwarders
Freight forwarders or forwarding agents are the most versatile operators in
the trade chain.
They collect goods from exporters, sometimes actually packing them for
shipment, transport them to ports of shipment by road, rail or barge and
arrange with the shipping company (or airline) for them to be loaded on
board their vessels.

30. •
•
•
d) Warehousing facilities
Warehousemen perform a valuable service prior to the shipment of goods
and after their arrival at the port of destination.
As they are always holding goods belonging to a third party, it is essential
that they meet stringent security requirements, the most important of
which is that they should be completely independent.
 
e) Carriers
Goods may be transported in a number of different ways and by several
types of carriers. There exists a need for independent road haulers, barge
operators and railway companies to carry goods on specific routes and to
be responsible for the whole journey.

31. •
•
•
f) Insurers
However well a consignment is packed, there is always the
possibility of damage being incurred in transit.
 
In some parts of the world, piracy and hijacking is prevalent.
 
Most shipments are financed by banks or other financial
institutions who want to ensure their security is properly insured.
 

32. •
•
•
g) Banks
Banks provide a multitude of services to every operator in the trade
chain and for every stage of any transaction.
 
Banking instruments and techniques which have been developed over
hundreds of years are made available with world­wide branch networks,
affiliates and correspondents.
 
The rapid growth of world markets owes much to the ability of these
financial institutions to adapt to change, to keep pace with development
and to maintain a high level of skill in handling transactions.

32

33. •
•
•
•
•
h) Factors
Now most international banks have a factoring subsidiary.
There is clearly a defined difference between the services offered by banks and
factors.
 
Every form of banking finance is effected with recourse to its customer, whereas
factors provide facilities for buying debt without recourse.
 
Complete factoring involves the exporter in handling all his documents to the
factor who takes an assignment over the debt of the overseas buyer.
 
Although expensive, factoring can take care over a number of administrative
operations for the exporter, leaving him to concentrate on his main business of
selling.

34. International Trade Risks
•
•
•
No transaction can be undertaken without risk to the importer or exporter,
although those risks can be significantly reduced by banks and insurers.
 
For the exporter, the main risks are commercial, political and foreign
exchange risks.
 
The main risks for the importer are commercial, involving short landing or
non delivery of goods and delivery of sub­standard goods.

35. Other Risks Involved In Cross Trading
a)
•
•
i.
ii.
iii.
Credit Risk
This is the risk that a counter party to a transaction fails to perform
according to the terms and conditions of the contract.
This may be due to one of the following reasons:
Inability of the drawee to pay under a bill of exchange which he or she
has accepted earlier or the failure of the importer to pay for goods
supplied.
 
Bankruptcy/Insolvency or Liquidation
 
Undeveloped mechanisms for efficient assessment of borrowers by credit
referencing agencies in the country.
 

36. •
•
•
b) Foreign Exchange risk
This is caused by the fluctuations in exchange rates over time.
 
Exporters may invoice the buyer in foreign currency (e.g. the currency of
the buyers country) or the buyer may pay in foreign currency. (e.g. the
currency of the exporters country).
 
The importers problem is therefore the need to obtain foreign currency to
make payments abroad  and the exporters problem is exchanging foreign
currency for the local currency.
 

37. i.
ii.
iii.
c) Sovereign Risk
This arises when a sovereign government of a country:
Obtains a loan from a foreign lender
Incurs a debt to a foreign supplier
Guarantees a loan or debt on behalf of a third party.
But then, either the government or the central bank refuses to pay the loan or
debt and claims immunity from the processes of the law.
 
d) Country Risk
This arises when a buyer does all he can to pay what he owes to the exporter
or lender but authorities of his country either refuse to make available to him
the foreign currency, or he is unable to pay because of political/economic
instability or imposition of foreign exchange controls
 

38. i.
ii.
iii.
e) Bank Risk
This arises due to the liquidation or insolvency of a bank that is supposed
to honour payments.
 
 
f) International Fraud
Examples include;
forged documentary credits
over/under insurance
cargo theft etc.

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39. International Fraud and Trade Based Money Laundering
•
•
The international trade system is subject to a wide range of risks
and vulnerabilities, which provide criminal organizations with the
opportunity to launder the proceeds of crime and provide funding
to terrorist organizations, with a relatively low risk of detection.
 
  The relative attractiveness of the international trade system is
associated with:
The enormous volume of trade flows, which obscures individual
transactions and provides abundant opportunity for criminal
organizations to transfer value across borders.

40. •
•
•
The complexity associated with foreign exchange transactions
and recourse to diverse financing arrangements
 
 The additional complexity that can arise from the practice of
commingling illicit funds with the cash flows of ‘legitimate’
businesses
 
 The limited recourse to verification procedures or programs to
exchange customs data between countries; and

40

41. • The limited resources that most customs agencies have available to
detect illegal trade.
 
 
 
Abuse Of The International Trade System
Researchers have documented how the international trade system can be
used to move money and goods with limited scrutiny by government
authorities.

42. Tax Avoidance And Evasion
•A number of authors, including Li and Balachandran (1996), Fisman
and Wei (2001), Swenson (2001) and Tomohara (2004), have
described the impact that differing tax rates have on the incentives of
corporations to shift taxable income from jurisdictions with
relatively high tax rates to jurisdictions with relatively low tax rates
in order to minimize income tax payments

43. Capital Flight
•
•
It has been shown that companies and individuals shift money from one
country to another to diversify risk and protect their wealth against the
impact o financial or political crises.
 
Several of these studies also show that a common technique used to
circumvent currency restrictions is to over­invoice imports or under­
invoice exports.
 

44. Trade-Based Money Laundering
•
•
Unlike tax avoidance and capital flight, which usually involve the
transfer of legitimately earned funds across borders, capital movements
relating to money laundering involve the proceeds of crime, which are
more difficult to track.
 
A number of these studies have also analyzed techniques to establish
whether reported import and export prices reflect fair market values.

45. The Role of Banks In International Trade
i.
ii.
iii.
iv.
v.
a) Provision of Banking facilities
Maintaining customers foreign & local accounts
Provision of short/medium term credit facilities
Providing documentary credit & documentary collection services
Negotiating Bankers Acceptances, Discounting & Factoring services
Arranging finance for exporters under various Bank of Ghana finance
schemes (private enterprise scheme, EDIF, etc.)

46. I.
II.
I.
II.
b) Collection & Transfer of funds & Settlement
Transmitting payments in foreign currency on behalf of importers/lenders
International money transfers
 
 
c) Provision of foreign exchange services
Provide foreign exchange in spot/forward market
Provide travel facilities, foreign currency, foreign draft, traveller's cheques

47. i.
ii.
•
•
•
•
•
•
•
d) Facilitation of International Trade by providing
information and data
Status report on foreign buyers, suppliers & banks (Banks rating) through
correspondence banks
 
General information on the Economic and Political situation in trading
countries such as:
Inflation
Foreign exchange position (supply & demand)
Exchange controls
Money supply
Balance of payment
Import/Export regulations
Interest rates

48. iii.
i.
ii.
iii.
iv.
v.
 Assisting in finding markets for goods and services
 
iv. Advising on various ICCO publications on INCOTERMS,
Documentary credits/Documentary collection and others
 
e) Provision of Specialized Trade Finance
 Standby Credit Arrangement
 Red Clause Credit and Green Clause Credit
 Bankers Acceptances
 Forfaiting
 Leasing/Hire Purchase
 

49. UNIT 2:
METHODS OF PAYMENT IN INTERNATIONAL TRADE
•
•
•
•
Objectives;
 To explain the different terms of payment in International trade
 
 To highlight the problems and risks associated with each mode of
payment
 
 To discuss the advantages and disadvantages in the methods of payment
to the supplier & buyer
 
 To make students aware of the relevance of each method of payment

50. Introduction
•
•
•
When an exporter sells goods or services to an overseas buyer, he
expects to be paid.
 
Terms of payment reflect the extent of guarantees required by the seller
to ensure payment before he sells his goods.
 
The extent of payment guarantee may vary depending on the credit
worthiness and reputation of the parties involved.

51. Payment Consideration
•
•
•
For the Seller:
 Advance payment
 The exporter needs payment if he cannot finance the production of the goods
and/or services ordered
 
 At time of shipment or rendering of service
 Exporter/seller want assurance of payment as soon as goods are or services are
rendered
 
 After shipment or rendering of services
 Supplier/seller is prepared to wait for some time after shipment/after services are
rendered

52. cont’d
•
•
•
For the Buyer:
 Payment in advance
 The buyer trusts that the contract will be fulfilled and he is therefore prepared to
pay in advance.
 
 At the time of shipment or rendering of service
 The contract may stipulate that or the buyer does not want to take risk
 
 After shipment or rendering of services
 The buyer possibly wants to sell the goods or wants to be satisfied that the
service has been rendered before he pays the seller

53. TERMS OF PAYMENT
•
•
•
1. Cash in Advance/Payment in Advance
 The buyer places the funds at the disposal of the seller prior to
shipment of the goods or provision of services.
 
In such circumstances, the parties may agree to fund the operation
by partial payments in advance or by progress payments.
 
This method of payment is expensive and contains some degree of
risk and as such, the buyer may request the seller’s bank to issue
advance payment bond in respect of monies advanced, to protect
himself from associated risks.

54. cont’d
i.
ii.
iii.
This method of payment is used when:
 
 The buyer’s credit is doubtful; or when the parties are doing business
for the first time.
 
 There is an unstable political or economic environment in the buyer’s
country
 
 There is a potential delay in the receipt of funds from the buyer, perhaps
due to risks beyond his control
54

55. cont’d
i.
i.
ii.
Advantages to the seller
 Immediate use of funds
 
 Disadvantages to the buyer
 Tying up his capital prior to receipt of the goods/services
 
 Has no assurance that goods/services will be:
        a. supplied
        b. received
        c. received timely
        d. received in the quality or quantity ordered

56. 2. Open Account
•
•
•
•
Open account trade is a system where goods and documents are
delivered to the buyer before payment is effected at a later date, usually
on a revolving basis.
 
This trade practice occurs usually between parties who have dealt with
each other over a specified time and have established a reasonable degree
of trust between themselves.
 
Open account provides for payment at a stated specific future date without
the buyer issuing any negotiable instrument.
 
The seller must have absolute trust that he will be paid at the agreed date.

57. cont’d
i.
ii.
i.
ii.
iii.
 Advantages to the buyer:
 Payment is effected after receipt of goods/services
 Payment is conditioned on the political, legal and economic issues
as previously discussed
 
 Disadvantages to the seller
 The title of goods is released without payment assurance
 The possibility of political events deferring or blocking movement
of funds to him
 Tied up capital until services are accepted and payment is made

58. 3. Collection
•
•
An arrangement whereby goods are shipped and the relevant
bill of exchange is drawn by the seller on the buyer, and/or
documents are sent to the seller’s bank with clear instructions
for collection through one of its correspondent banks located in
the domicile of the buyer.
 
The conditions under which the document of title and other
documents covering the goods will be released to the buyer/
importer are spelt out in a Collection Order, which the exporter’s
bank sends to the importer’s bank.

59. Normal Precautions To Be Taken By The Seller
•
i.
ii.
iii.
iv.
The seller should:
obtain a credit report or status opinion on the buyer,
 
obtain an economic and political analysis of the country of import
concerning political stability, foreign currency position and foreign
exchange regulations.
 
not consign the goods to the buyer, nor consign the goods to the
buyer’s bank without that bank’s prior agreement.
 
establish alternative procedures for the resale, reshipment or
warehousing of the goods in the event of non­payment by the buyer.

60. Collection Procedure
•
•
•
•
•
The exporter ships the goods and obtains the shipping documents and usually draws
a Draft
 
The exporter submits the draft(s) and/or documents to his bank, which  acts as his
agents
 
The exporter’s bank sends the Draft and other documents along with a collection
letter to a correspondent bank
 
acting as an agent for the remitting bank, the collecting bank notifies the buyer upon
receipt of the Draft and documents, and
 
all the documents, and usually title of the goods, are released to the buyer upon his
payment of the amount specified or his acceptance of the Draft for payment at a
specified date.

61. Collection cont’d
i.
ii.
iii.
i.
ii.
iii.
Advantages to the Seller
documentary collections are uncomplicated and inexpensive
documents of value are not released to the buyer until payment or
acceptance has been effected
collections may facilitate pre­export or post­export financing
 
Disadvantages to the Seller
ships the goods without an unconditional promise of payment by the
buyer
 there is no guarantee of payment or immediate payment by the buyer
 ties up his capital until the funds are received

62. Collection cont’d
i.
i.
ii.
Advantage to the Buyer
collections may favour the buyer since payment is deferred by him
until the goods arrive or even later if delayed payment arrangements
are agreed to
 
Disadvantages to the Buyer
 by defaulting on  bill of exchange, he may become legally liable
 trades reputation may be damaged if the collection remains unpaid

63. Types of Collection
a)
•
•
•
i.
ii.
Documentary/Clean Collection
An arrangement where the seller draws a bill of exchange on the buyer
with relevant documents for the value of the goods or services and
presents the bill of exchange to his bank.
 
The seller’s bank sends the bill of exchange along with a collection
instruction letter to a corresponding bank, usually in the same city as the
buyer’s.
 
A clean collection may represent:
 an underlying merchandise transaction, or
 an underlying financial transaction

64. b) Direct Collection
•
•
•
•
An arrangement where the seller obtains his bank’s pre­numbered direct
collection letter, thus enabling him to send his documents directly to his
bank’s correspondent bank for collection.
 
This kind of collection accelerates the paper­work process.
 
The seller forwards to his bank a copy of the respective instruction/
collection letter that has been forwarded directly by him to the
correspondent bank.
 
The Remitting Bank treats this transaction in the same fashion as a normal
documentary collection item, as if it were completely processed by such
Remitting Bank.

65. 4. Documentary Credit
•
•
•
Documentary credit or Letter of Credit is an undertaking issued by a
bank for the account of the buyer or for its own account, to pay the
Beneficiary the value of the Draft and/or documents provided that the
terms and conditions of the Documentary Credit are complied with.
 
This Documentary Credit arrangement usually satisfies the seller’s
desire for cash and the importer’s desire for credit.
 
The Documentary Credit offers a unique and universally used method
of achieving a commercially acceptable undertaking by providing for
payment to be made against complying documents that represent the
goods and making possible the transfer of title to the those goods.

66. Cont’d
66
•
a)
b)
c)
d)
e)
f)
The meaning of Documentary Credit embodies the following. It is:
a written undertaking given by a bank, known as an issuing bank or
opening bank;
to a seller, known as a beneficiary;
at a request and on the instructions of its customer (buyer), known as
the D/C applicant;
to pay either at sight or at a specific future date;
a stated sum of money;
against delivery of shipment and submission of stipulated documents
and fulfilment of all the terms and conditions in the D/C.
 
 
 

67. Cont’d
67
•
•
a)
b)
•
In other words, a documentary credit is a conditional payment
instrument made by the issuing bank in favour of a designated
beneficiary.
It is especially appropriate in the following circumstances:
When the importer is not well known, the exporter selling on credit
terms may wish to have the importer’s promise of payment backed by
his banker;
 
On the other hand, the importer may not wish to pay the exporter
until it is reasonably certain that the merchandise has been shipped in
good condition and/or in accordance with his instructions.
A documentary credit, in this case, can satisfy both the exporter and
the importer.
 

68. It should be noted that all the aforementioned are methods of
obtaining payment for goods shipped and not methods of obtaining
finance.
68

69. BENEFITS OF DOCUMENTARY CREDIT
a)
b)
c)
Provides a specific transaction with an independent credit backing
and a clear­cut promise of payment.
 
Satisfies the financing needs of the seller and the buyer by placing
the bank’s credit standing, distinguished from the bank’s fund, at the
disposal of both parties.
 
May allow the buyer to obtain lower purchase price for the goods as
well as longer payment terms than would open account terms, or a
collection

70. cont’d
d)  Reduces or eliminates the commercial credit risk since payment
is assured by the bank which issues an irrevocable Documentary
Credit.
 
e) Reduces certain exchange and political risks while not necessarily
eliminating them
 
f)   May not require actual segregation of cash, since the buyer is
not always required to collateralize his Documentary Credit
obligation to the issuing bank.

70

71. cont’d
g)   Expands sources of supply for the buyers since certain sellers are
willing to sell only against cash in advance or Documentary Credit
 
h)   Provides clear­cut guarantee of payment
 
i)  Provides the buyer with the assurance that required documents will
be received

72. UNIT 3:
INCOTERMS/TERMS OF DELIVERY/SHIPPING TERMS
•
•
Introduction
Incoterms, shipping terms or trade terms are one of the key elements of
international contract of sale of goods.
 
They identify the respective responsibilities of the trading parties in the
quotation for each contract of sale.
 

73. Incoterms
•
•
•
•
“Incoterms” is an abbreviation of “International Commercial Terms”.
 
It was published by the International Chamber of Commerce in Paris
and has its latest version, “Incoterms 2010”,  which became effective
on January 1, 2011.
 
Incoterms define at the minimum level, the division of cost between
buyers and sellers, the point at which delivery occurs, which party is
responsible for import and export clearance.
Incoterms also give some information regarding documentation.
 

74. Cont’d
•
i.
ii.
Incoterms provide generally four pieces of Information;
Information on the transfer of risk ­ It defines at which place the
risks of cargo loss and damage are transferred from the seller to
the buyer during transportation operations.
 
Information on the division of cost ­ It defines how costs
resulting from the transport operations are shared between the
seller and the buyer.
 

75. Cont’d
iii. Information on the document ­ It defines who will  provide
the required documents.
 
iv. Information on port of shipment and port of delivery – It defines
where cargo or goods be loaded and place of discharge

75

76. •
•
•
In international trade, there are likely to be three separate contracts for the
transportation of goods;
 From the seller’s or exporter’s premises in his/her country to a named
point or place in the importer’s country
 
 From the transport operator’s premises in the exporter’s country to the
named point in the importer’s country
 
 From the port of discharge in the importer’s country to the importer’s
own factory
 

77. Main Changes In The Incoterms 2010
•
•
•
•
•
•
Guidance Notes have been included before each rule
Facilitates usage of electronic records if agreed or where customary
Clearly allocates the Terminal Handling Charges (THC) in the relevant
terms
For ‘String Sales’, Incoterms 2010 clarifies the obligation to ‘procure
goods shipped’ as an alternative to the obligation to ship goods
Allocates obligations to obtain or render assistance in obtaining
security related clearances
Insurance cover has been altered with a view to clarify the parties’
obligation relating to insurance.

78. Cont’d
•
i.
ii.
iii.
iv.
Incoterms is now separated into two groups, those applicable to all
modes of transport and those only applicable to sea and inland
waterway transport. The two new additions are DAP and DAT and
four deletions, DAF, DDU, DEQ and DES
 
  Incoterms 2010 Applicable For Sea and Inland Waterway Transport;
FAS: free alongside ship
FOB: free on board
CFR: cost and freight
CIF: cost, insurance and freight

79. Cont’d
i.
ii.
iii.
iv.
v.
vi.
vii.
Incoterms 2010 Applicable For All Modes of Transport;
EXW: ex works
FCA: free carrier
CPT: carriage paid to
CIP: carriage and insurance paid to
DAT: delivered at terminal
DAP: delivered at place
DDP: delivered duty paid
 

80. PURPOSE OF INCOTERMS
•
•
Main task of incoterms is;
to define the sharing of cost and transfer of risk or damage over the
goods, up to an agreed place
 
to avoid misunderstanding and disputes among the parties over the
sharing of costs and transfer of risk or damage of the goods
 
Incoterms are used directly by buyers and sellers, and indirectly by banks,
insurers and carriers/forwarding agents

81. Users of Incoterms
•
•
a)
a)
Banks
 Most letters of credits will state an Intercom
 This enables banks to check, to an extent, that:
 The documents called for in the credit are consistent with the term
used
 
 The documents presented are consistent with the term used

81

82. Cont’d
•
•
•
•
Insurers
 If there is loss or damage to cargo, insurers will be at pains to
establish exactly where it has occurred and therefore whether the
buyers or sellers were responsible
 Incoterms determine whether it is the buyer or seller that is a risk
 
Carriers/Forwarding Agents
 To determine which party will be responsible for payment of freight
charges and from which port of loading to port of discharge or any
intermediary
 To determine which party will be responsible for the various activities
in transportation

83. FORMAT OF INCOTERMS
•
•
•
•
All incoterms consist of 3 alpha characters
 Incoterms are followed with either a “DELIVERY PLACE/PORT
OF LOADING” or “PLACE OF DESTINATION/PORT OF
DISCHARGE”
 E and F terms are usually followed with a place of delivery/port of
loading
 C and D terms will usually be followed with a place of destination/
port of discharge

84. Cont’d
•
•
•
 The named place stated after the incoterms, is the place up to
which the seller pays the freight costs. e.g., “EXW New York”
 
 Delivery Point is the point at which the risk transfers from the
seller to buyer.
 
 “Delivery”, in the incoterms sense, has nothing to do with
transfer of ownership. Title of the goods always lies with the
documents

84

85. COMMON INCOTERMS
1.
•
•
•
•
EXW – Ex Works (Aluworks, Tema­Ghana)
Exporter/Seller is responsible for producing the goods and:
 Making them available at the factory premises for the importer
 Providing the buyer with commercial invoice for goods
 
Buyer/Importer is responsible for:
 Local transport and insurance to the port of loading
 On­ and off­ loading charges

86. •
•
•
•
2.  FAS­ Free Alongside Shipping (KINTAMPO, Tema Port)
 Exporter/seller must arrange to:
 Deliver the goods at the point and port of loading named in the contract
 Pay for the production of goods, all charges up to delivery of goods
including local transport and insurance cost to the side of the named ship
 
 Buyer/Importer is responsible for:
 Choosing the carrier to transport the goods abroad and paying the cost of
freight from the port of loading including the cost of loading on board the
vessel to the port of discharge
 Arranging and paying for any export permit or export taxes, excluding
value added tax

87. •
•
•
•
•
Free on board means that the buyer does not pay for transporting or
insuring the goods from the seller’s premises.
 The Exporter/seller must:
 Pay for the transportation to the named port of shipment
 Provide and pay for the export license
 
 The Buyer/Importer must:
 Nominate the carrier to carry the goods
 Give the seller/exporter the details of the ship/airline, sailing time, airline
flight time/date

3.  FOB ­ Free On Board of vessel named carrier/ship (GYATA,
Tema Port)

88. 4.  CFR – Cost and Freight (named port of discharge, Tema Port)
•
•
•
•
The seller/exporter must:
 Nominate the carrier and so make the contract of carriage
 Pay for the transportation of the goods to the place of shipment
and local insurance
 
The buyer/importer must:
 Pay for the marine insurance of goods from the time they are
taken on board to the port of discharge
 Pay for the unloading cost at the destination

89. 5. CIF – Cost, Insurance and Freight (Named Port of discharge,
Tema Port)
•
•
•
The seller has the same responsibility and obligation as that of C&F,
except an added responsibility of arranging and paying for
insurance.
 
Buyer should arrange to pay for handling and off­loading charges
and:
 Obtain the import license
 Arrange to pay the import duties; and
 Pay for local transport and insurance cost from the port of
discharge to the buyer’s premises

90. 6.  DDP – Delivered Duty Paid (Buyer’s Premises)
•
•
•
Means that the seller delivers the goods to the buyer, cleared for
import, and from any arriving means of transport at the named
place of destination.
 
The seller must pay all import duties including value added tax of
the importer’s country and also provide relevant import license.
 
The seller has an added responsibility for arranging and payment
of import license of import duties and value added tax
 

91. 7.  DAT – Delivered At Terminal (Shed One, Tema Port)

•
•
•
•
•
Means that seller delivers when the goods, once unloaded from the
arriving means of transport, and placed them at the disposal of the
buyer at a named terminal at the named port or place of destination
 
Exporter/seller
 delivers the goods on the terminal at the named port of destination
 pays for unloading cost
 
 Buyer/importer
 accepts delivery of goods at named port of destination
 is responsible for local transport, insurance and others

91

92. 8.  FCA – Free Carrier (Boankra Inland Port, Kumasi)
•
•
•
•
•
•
This term is used where inland port is used in the transportation of goods.
The Exporter/seller:
 delivers goods to Boankra inland container depot
 completes export and customs documentation including obtaining export
license
 
The importer makes all arrangements at his own cost and risk to cover
transport of goods to his own premises from Inland Container Depot
 arranges for appropriate insurance and obtains policy or certificate
 obtains the import license
 pays for import duties

93. 9.  CPT – Carriage Paid To (Named place of destination)
•
•
•
•
•
Similar to CFR, except that exporter must arrange and pay for
transport to the named port of discharge, which could be an inland
container depot.
The exporter/seller:
 completes export and customs requirements including obtaining any
export license
 pays export duties and taxes
 
The buyer/importer must:
 obtain import license and pay all the import duties, including value
added tax
 arrange and pay for insurance for the goods, from time the goods are

94. 10.  CIP – Carriage and Insurance Paid (to named place of
discharge)
•
•
•
•
The seller/exporter:
 pays for the freight cost
 pays for the insurance charges during carriage
 
 The buyer/importer:
 arrange for import license or permit
 pay import duties and taxes including value added tax
 

95. UNIT 4:
DOCUMENTS USED IN INTERNATIONAL TRADE
•
•
•
•
    Objectives;
 To know the documents used in the International Trade business
 
 To explain the impact of modern transport on International Trade
 
 To explain the type and features of documents used in
International Trade
 
 To discuss the types of bill of lading and other documents used in
International Trade

96. Introduction
•
•
•
   Documentation
Documentation in international trade transactions provides tangible
evidence that goods have been ordered, produced and dispatched in
accordance with the buyer’s requirement or pre­sale contract between the
seller and buyer.
Documentation is also to satisfy government regulation in the country of
the exporter or buyer and has thus, become an increasingly important
factor in obtaining finance for International Trade.
Documents have become an important part of international business
because of the complex delivery terms of shipment, payment mechanism
and mode of settlements. Documents can be classified as commercial and
financial.

97. The Impact of Modern Transport on International Trade
•
•
The trend towards integrated (door to door) and multi­modal transport
accelerated by the advent of the container has made certain traditional
“critical point” under FOB, CFR and CIF no longer important as a point
for the division of functions, costs and risks between the contracting
parties.
 
In addition, since a key function of the transport document is to make
evident the goods ordered and their condition, it should be issued at a
point where the carrier has reasonable means of conducting a check. In
modern transport operations, this point has shifted from the ship’s rail to
seaport or inland terminals. Consequently, there is a requirement for
documents that specify goods received for shipment.
 

98. TRANSPORT DOCUMENTS
1.
•
•
•
Bill of Lading
There is always a need for a document to cover the movement of
goods from one point to another, either by sea, road or rail.
 
Sea transport covers about 70% of the world’s trade, so documents
covering goods by sea are very crucial and critical for the
sustenance of trade.
 
Bill of lading is a document issued by the shipping line covering
goods being transported on sea to the owner of the goods.

99. cont’d
•
•
•
It indicates the port of loading, where the carrier will take the
goods and the port of discharge.
 
It also indicates the date, which goods departed from the port of
loading and the status of the freight.
 
The document also helps in the determination of the latest
shipment date inserted in the letters of credit.

99

100. The Functions of a Bill of Lading
1)
2)
3)
4)
It acts as a receipt for the goods from the shipping company to the
exporter
 
It is evidence of the contract of carriage between the exporter and
the carrier
 
It acts as a document of title for goods being shipped overseas.
The goods are released from the overseas port only by producing
one of the original bills of lading.
 
A bill of lading is a quasi­negotiable document. Any transferee for
value who takes possession of an endorsed bill of lading obtains
good title to the goods.

101. cont’d
•
 
Original bills of lading  are usually issued in three original sets and
any of the original bills of lading enables the possessor to obtain
the goods.

10
1

102. Transfer of Title to Goods
•
i.
Title to the goods can be transferred by the sender, using a marine
bill of lading in one of three ways:
Issuing a bill of lading to order and endorsed in blank.
      The title to the goods can be obtained by anyone presenting a
signed original copy of the bill of lading
 
ii.  Issuing the bill of lading to the order of the named buyer or
bank overseas
 

103. cont’d
•
iii.  Issuing the bill of  lading to the order of a named buyer, but
arranging for the bill of lading to be presented to the buyer   through
the international banking system
 
The bill of lading will indicate the state in which goods were
received for shipment (clean, dirty or damaged)

10
3

104. Types of Bill of Lading
a)
•
•
•
•
•
Liner Bill of Lading
This is a marine bill of exchange for carriage by a vessel on a
scheduled run rather than an “Adhoc” sailing, without a scheduled
route or timetable.
 It has the same function as the ordinary Marine bill of exchange
 It provides evidence of contract of carriage
 It serves as receipt for the shipper/exporter.
 It is a document of title­ the holder has “Constructive” control
over the shipped good.

105. cont’d
•
•
b)  Short Form Bill of Lading
This is a bill of lading which does not contain the shipping
company’s terms and conditions of carriage.
 
A short form bill of lading can therefore not be a contract of
carriage between the shipping company and the exporter or
overseas buyer, but it refers to the conditions of carriage which
can be found on the master document or on a copy of the carrier’s
standard condition.
 

106. cont’d
•
•
•
c)  Container Bill of Lading
Shipping companies issue a bill of lading which simply acts as a
receipt for a container with goods packed in it.
 
Container bills of lading can be issued to cover goods being
transported on  traditional port to port.
 
Palletized cargoes, and cargoes contained on lash barges, which are
loaded on larger vessels qualify for issuance of container bills of
lading.
10
6

107. cont’d
•
•
d) Combined or Through Bill of Lading
Combined transport bill of lading may show evidence that goods
have been collected from a named inland place and have been
dispatched to another seaport or inland container depot in the
importer’s country.
 
The goods, although carried by two or more modes of transport,
are shipped under a single contract of carriage.

108. cont’d
•
•
•
e)  Charter Party Bill of Lading
A charter party bill of lading is issued by the hirer of a ship to the
exporter and the terms of the bill are subject to the contract of hire
between the ship’s owner and hirer.
 
The contract is therefore between the exporter and hirer of the vessel,
not the ship owner.
 
A bill of lading issued for the journey will state “Subject to charter
party” and the contract of carriage is subject to contract for the hire of
the vessel

10
8

109. cont’d
•
•
f)  Trans­shipment Bill of Lading
These are used when the goods have been transferred from one
vessel to another vessel at a named trans­shipment port.
 
 
Once again the carrier has full responsibility for the whole journey.

110. 11
0
•
•
i.
ii.
•
•
2.  Sea Way Bill
A sea way bill is a transport document which is issued by the
shipping line.
It is a document which gives details of a consignment of goods and
it acts as:
 a contract between the shipping company and the exporter or
overseas buyer
 a receipt by the shipping company for the goods received and so,
provides evidence of shipment.
A sea waybill is non­negotiable and is not a document of title.
It is used instead of a bill of lading.

111. •
•
•
•
•
3.  Air Way Bill/Air Consignment Note
An air waybill is a waybill for goods transported by air.
It is a contract of carriage and receipt by the Airline for goods
received into custody.
Air way bill is not a document of title.
The airline will hand the goods to the consignee at the port of
discharge without the consignee having to present an original copy
of the waybill
An air waybill provides evidence of dispatch of goods with detailed
flight date, freight, port of loading and discharge, consignee and
signature of the airline.

112. •
•
•
4.  Road Consignment Note/Truck Receipt
A road consignment note is a receipt issued by a carrier for goods
that are transported by road.
 
The note specifies the name and address of the supplier to the
consignee, place of delivery and the place where the goods are to
be taken by the carrier.
 
The note acts as both a receipt and a delivery order, and is neither
non­negotiable nor a document of title.

11
2

113. •
•
•
•
5.  Railway Consignment Note
This is a note issued by a railway corporation for goods dispatched
by rail.
 
It is a contract of carriage between the supplier and the railway
company.
 
The railway authorities will release the goods at their destination to
the consignee, who must apply for them and give proof of identity.
 
It is not a document of title.

114. 11
4
•
•
•
6.  Post Office Receipts
Post office receipts are issued by the relevant postal agencies for
goods dispatched by parcel post.
 
They, thus, provide details and confirmation of dispatch of goods.
 
The goods will be sent directly to the person or company to whom
the parcel is addressed.

115. COMMERCIAL DOCUMENTS
•
•
•
i.
ii.
1.  Pro­forma Invoice
Pro­forma invoice is the price quotation by an exporter to a potential
overseas buyer.
The quotation indicates description of goods, unit price , total price,
delivery terms, and payment terms.
 
Pro­forma invoices are used for the following purposes:
 The overseas buyer might need to present a pro­forma invoice to
government agencies or bank in his country in order to obtain an
import license and foreign exchange for payment of goods
 Customers importing under documentary collection are supposed to
obtain prior approval from their respective banks before importing
goods into the country

116. cont’d
iii.They serve as a price quotation and might include the terms of
sale
 
iv.  In certain cases, they can be used as a document of tender for
an export contract
 

117. 11
7
•
•
i.
ii.
iii.
iv.
2.  Commercial Invoice
This is a demand note issued the supplier for goods or services sold or a
claim for payment in connection with goods already supplied to a buyer.
 
A commercial invoice is a claim for payment for goods under the terms of
the commercial contract.
 
 The commercial invoice will include:
 detailed description of goods, quality, unit price and total price
 the terms of delivery or Incoterm
 terms of payment – open account, documentary credit or advance
payment
 method of settlement – by swift, telegraphic transfers, mail transfers,
foreign banker’s draft

118. •
•
3.  Certified Invoice
 It is a commercial invoice, which also includes a statement by the
exporter about the condition of goods sent or their country of
origin.
 
Some form of statement might be provided at the request of the
buyer or for the benefit or customs authorities

119. •
•
•
•
4.  Consular Invoice
It is a commercial invoice, which is prepared on a form, printed in the
exporter’s country by the consulate of the buyer’s country.
 
The Trade Attaché or Consular then stamps it.
 
The purpose of a Consular invoice is to help the government of the
importing country to control imports in the country.
 
Its other function is to provide information which forms the basis for
which import duties are paid on goods imported

120. •
•
•
5.  Certificate of Origin
This is a declaration which states the country of origin of the goods
and is common place in countries wishing to identify the origin of
all imported goods.
 
A certificate of origin is a statement signed by an appropriate
authority certifying that goods were produced in the exporter’s
country.
 
The forms should be completed by the supplier and may be
authenticated by the Local Chamber of Commerce or other
authorized body in the exporter’s country.

12
0

121. •
•
•
6.  Weight Note
This is a document issued by the exporter or third party declaring the
weight of the goods in the consignment.
 
7.  Packing List
This document gives the details of the goods which have been packed.
 
It is normally required by Customs Excise and Preventive Services
whenever goods are being cleared.
 
 

122. 12
2
•
•
•
This is a certificate issued by an independent third party resident in the
exporter’s country, ensuring that goods being imported are of  high
quality with reasonable price comparisons.
 
The mandate for companies operating in Ghana like SGS, Cotecna,
Bureau de Veritas/ Ghana Standards Board  is to check on quality, as
well as price comparisons.
 
The mandate of the inspection companies operating in Ghana is
derived from the Import declaration form issued by the Ministry of
Trade.
8. Inspection Certificate–Pre­Shipment Inspection

123. 9.  Final Classification and Valuation Report –
Destination Inspection
•
•
•
This is a document issued to classify goods that have been imported
into the country.
 
The document also shows the value of goods and thus, enabling the
Customs Excise and Preventive Service to charge the relevant import
duties as well as sales tax or value added tax.
 
The importer is required to submit a copy of Importation Declaration
Form to the appointed inspection company in Ghana to enable them
conduct the inspection and the issue the Destination Inspection
Certificate which will classify the goods for CEPS valuation purposes.

124. INSURANCE DOCUMENTS
•
•
•
•
  Insurance Certificate
It is an evidence that shipment is insured against loss or damage while
in transit.
 
Unlike domestic carriers, ocean going steam ship companies assume no
responsibility for the merchandise they carry, unless the loss is caused by
their negligence.
 
Marine insurance on an international transaction may be arranged by
either the exporter or the importer, depending on the terms of sale.
 
The laws of a country require  the importer to buy such insurance, thus
protecting the local industry and saving foreign exchange.

125. 12
5
a.
b.
•
c.
•
Basic named perils – sea, jettisons, explosions and hurricanes
 
Broad named perils – theft, pilferage, non­delivery, breakage and
leakage in addition to the basic perils.
Both policies contain a clause that determines the extent to which
losses caused by an insured peril will be paid.
 
All risks cover all physical loss or damage from any external cause
and is more expensive than the policies previously mentioned.
War risks are covered under a separate contract.
 

Three kinds of Marine Insurance Policies:

126. cont’d
•
•
The premiums charged depend on a number of factors, among
which are the goods insured, the destination, the age of the ship,
whether the goods are stowed on deck or under deck, the volume
of business, how the goods are packed and the number of claims
the shipper has filed.
 
Because neither the policies nor the premiums are standard, it is
highly recommended that the exporter obtains various quotations.

127. 1.
•
•
•
A Cover Note/Letter of Insurance
This is issued by an insurance broker to provide notice that steps are
being taken to issue a certificate or policy
 
2.   A Certificate of Insurance
It shows the value and details of the shipment and risks covered.
 
It is signed by the exporter/importer and the insurance company.
Only a certificate of insurance is required when the policy of the
exporter/importer provides “Open Cover” for the whole of its
export trade for one year.
Three Basic Insurance Documents are:

128. cont’d
12
8
•When an exporter/importer takes out an open cover with any
reputable insurance company for his export or import trade, a
certificate of insurance for each individual shipment will be
provided by the Insurance Company.

129. 3.  Insurance Policy
•
•
a)
b)
c)
d)
e)
This gives details of risks covered and is evidence of a contract of
insurance.
Most insurance policies have an “All Risk Policy”, and the main risks
covered are:
 Perils at sea – accidental loss or damage caused by sinking, collision,
sea water, heavy weather and stranding
 Jettison – loss caused by a decision of the master of the ship to
throw goods over board so as to lighten the vessel in an emergency
 Fire, including smoke damage
 Theft – forcible theft of goods rather than pilferage
 Damage in loading, trans­shipment or discharge

130. cont’d
•
•
Policy or certificate will not cover losses or damage from strikes,
riots, civil commotions, wars, coup d'état or capture and seizure of
vessel and other force majeure.
 
These risks must be insured separately by payment of an additional
premium.

131. FINANCIAL DOCUMENTS
•
a.
b.
In international trade, there are two financial documents which
provide for payment by the buyer. These are:
 after a period of credit
 
 establishing a clear legal undertaking by the buyer to make the
payment either by the Bill of Exchange or promissory note.

132. •
•
•
•
•
A bill of exchange is defined by the Bill of Exchange Act 55, 1961
as
 an unconditional order in writing
 addressed by one person to another
 signed by the person drawing it
 requiring the person to whom it is addressed to pay on demand or
at a fixed or determinable future date, a certain sum in money, and
 acting to the order of a specified person, or to bearer
1.  A Bill of Exchange

133. •
•
•
•
•
Bills of exchange can be classified in two types:
a.  Sight Bill
The bill requires payment on sight or on demand drift.
All that is required is for the drawee to authorize payment via the
banking system.
 
b.  Term Bill (Tenor or Usance)
Bills which are payable at a future date are called Term Bills.
With term bills, payment is due 90 days after sight.
 
Types of Bill of Exchange

134. cont’d
•
•
•
When the bill of exchange is presented to the drawee, he should
accept it if he wishes the bill to be honoured.
 
The drawee would sign the bill of exchange on the front and insert
the date of acceptance.
 
He would be legally bound to pay 90 days after the date of
acceptance shown on the bill of exchange.
13
4

135. Subdivision of Bill of exchange
a)
•
•
•
Trade bills – these are bills which are drawn on and are accepted
with the underlying transaction being for commerce or trade.
These bills drawn on trading entities are accepted by some.
Such bills from individual persons are risky by their very nature.
b)  Bank bills – these are bills are drawn on accepted by the banks.
Such bills carry very little risk, especially if the bank accepting it is
a first class bank.
c) Accommodation bills – these are used by banks to provide
accommodation facilities for their clients
d) Documentary bills and clean bills

136. •
•
•
•
It provides a convenient method of collecting payment from
foreign buyers
 
The exporter can seek immediate finance using term bills of
exchange instead of having to wait until the period of credit expires
 
On payment, the foreign buyer keeps the bill as evidence of
payment. It therefore serves as a receipt.
 
If a bill of exchange is dishonoured, it may be used by the drawer
to pursue payment at maturity.
Advantages of Using Bill of Exchange

137. •
•
•
•
•
•
•
A promissory note is defined in the Bill of Exchange Act of Ghana,
Act 55, 1961 as:
 an unconditional promise in writing
 made by one person to another
 signed by the maker
 engaging to pay
 on demand or fixed or determinable future time
 a sum of money
 to the order of a specified person or to bearer
2.  Promissory Note

138. UNIT 5:
DOCUMENTARY CREDIT
•
•
•
•
•
•
•
 Objectives;
 To define Documentary Credit
 To examine the general instruction for opening Documentary Credit
 To explain the parties involved in the Documentary Credit
 To describe the types and benefits of documentary credit
 To help students to understand the specialized credit available
 To explain the financing mechanisms under documentary credit facility
 To discuss the practical handling of discrepant documents under
documentary credit
 

139. Introduction
•
•
It is the only payment mechanism which usually satisfies the
seller’s desire for cash and importer’s desire for credit.
 
A Documentary Credit is a written undertaking issued by a bank,
on behalf of the buyer, to the seller, to pay for goods or services,
provided that the seller presents documents which comply fully
with the terms and conditions of the credit
 
 

140. TYPES OF DOCUMENTARY CREDIT
a)
b)
•
Irrevocable Credit – incapable of cancellation or modification
except with the consent of the Beneficiary
 
Revocable Credit – can be cancelled or modified by the importer
at anytime without the consent of the beneficiary.
 
The cancellation is subject to the customer remaining liable in
respect to any negotiation

14
0

141.  PARTIES TO THE DOCUMENTARY CREDIT
1)
2)
3)
4)
Applicant/Buyer/Opener – The party on whose behalf it is issued
 
Issuing Bank – The bank that issues it and acts for the Applicant
 
 Advising Bank – The Bank through which documentary credit is
conveyed to the beneficiary
 
Beneficiary – the party to whom the documentary credit is
addressed and who will receive payment.

142. cont’d
14
2
•
•
5) Confirming Bank – the bank that adds its confirmation to a
credit upon the issuing bank’s authorization or request.
 
Sometimes, an advising bank is requested by the issuing bank to
add an additional commitment to pay the beneficiary.
 
If it agrees to the request, this advising bank will take a dual role.
 
 

143. BANK’S CONSIDERATION BEFORE ISSUING CREDIT
a.
•
•
Status Report/Credit Standing on the Beneficiary
For the protection of both the issuing bank and the applicant,
consideration should be given to a status report on the integrity,
credit worthiness and track record of the beneficiary
 
Such reports could be obtained from the beneficiary’s bankers
through the importer’s correspondent bank network

144. cont’d
14
4
•
•
•
b.  Status Report/Credit Standing on the Applicant
An opening bank needs to ensure that the applicant is a customer
with high integrity and repayment ability.
 
For a new customer, a marginal deposit may be required.
 
For existing customers with a credit limit, a D/C line of credit will
be earmarked and deducted for the amount of the credit or added
to their existing facilities.

145. cont’d
•
•
•
c.  Facilities
The Bank should have an appropriate import facility put in place.
 
All cannons of lending should be strictly applied, especially the
foreign exchange component of this facility should be well
highlighted.
 
If the customer does not have import facility or approved line of
credit, the bank should take 100% total deposit cover against the
establishment of Letters of Credit.
 

146. 14
6
•
•
•
d.  Nature of Goods
A D/C issuing bank undertakes to pay a seller against his goods as
the collateral.
 
Therefore, the bank is quite concerned about the nature of the
goods and in particular its marketability and durability.
 
The goods are considered valuable to guard against the insolvency
of the applicant (buyer) to pay for the shipping documents.
 
cont’d

147. 14
7
•
•
e.  Control of Goods and Title Documents
In all cases, an opening bank is prepared to issue a credit calling
for a full set of title documents
 
This allows the issuing bank to take control over the goods only if
the bills of lading are made out in the name of the issuing bank or
“to order” and “blank endorsed”.
 
 
cont’d

148. 14
8
f.
•
•
•
Nature of the Credit
Whether it is a local D/C or a foreign D/C and in particular the
means of delivery of the goods.
 
g.  Type of Currency
Whenever a documentary credit is issued in a currency other than
that of the buyer, an exchange risk occurs.
 
If the credit is issued in a rare currency or exposed to great
fluctuation, it is advisable for the issuing bank to remind its
customer to take foreign exchange cover.
 
cont’d

149. 14
9
•
h.  New Business and Cross­selling
The possible volume of new business and the chance of cross­
selling may also be a consideration.
 
 
 
cont’d

150. THE TRIANGULAR CONTRACTUAL AGREEMENT
15
0
•
i.
ii.
iii.
Under documentary credit operations, there exists a distant
triangular contractual agreement. That is;
 Firstly, the sales contract between Buyer and Seller (proforma
arrangement)
 
 Secondly, the Application and Security Agreement or the
Reimbursing Agreement between the Buyer and the Issuing
Bank
 
 Thirdly, the Documentary Credit between Issuing Bank
through the Advising Bank and the Beneficiary

151. GENERAL INSTRUCTIONS FOR OPENING A DOCUMENTARY
CREDIT
a)
•
b)
•
Responsibility of the Issuing Bank – its duty is to receive
shipping documents on behalf of the importer which purport to
comply with the condition stated in the documentary credit.
  It deals in documents but not in goods
 
Availability – the expiry date must always be given by the
importer.
  The expiry date can of course be extended on the instruction
of the customer.

152. c) Negotiation – this instruction should be used where drafts are
drawn by the beneficiary on the bank named to negotiate.
 
d) Acceptance /Payment – these instructions are appropriate where
the currency of the credit is that of the country of the beneficiary
who is to draw draft for acceptance on an issuing bank or the
confirming bank
15
2
cont’d

153. •
e) Documents Required – details of documents required in
documentary credit should be mentioned in the application
form.
It is not sufficient to say “usual documents”
 
f) Delivery Terms – applicant should state the delivery terms
to avoid ambiguities in transport and delivery charges
 
cont’d

154. g) General – unless the letter of credit states otherwise, shipping
documents bearing reference to other charges in addition to
freight charges will be accepted.
 
h) Unless instructions are given to the contrary, issuing banks
will take up documents presented to them up to 21 days from
the date on the transport document Bill of Lading /Airway Bill

15
4
cont’d

155. UNIT 6:
OVERVIEW OF EXPORT FINANCE
•
•
•
•
•
•
  Objectives;
To discuss the factors which affect Export Finance
To explain the criteria used in the financing of the trade cycle
To describe the trade cycle in relation to international business
To explain pre and post shipment financing
To discuss the factors which make trade finance attractive to banks
To discuss the traditional and non­traditional facilities provided by
banks in export trade

156. Introduction
•
•
a)
b)
c)
d)
e)
Financing the pre­shipment, or post­shipment period is an
important consideration for any exporter.
 
The method of financing chosen by the exporter will be influenced
greatly by the following factors:
 The terms of trade
 The payment mechanism
 Currency and cash flows consideration
 The cost of funds/pricing
 The availability of any export credit insurance

157. •
•
•
Most exporting companies sell their goods on terms which
typically do not exceed 180 days and payment mechanism will
vary from the open account through documentary collection to
irrevocable documentary credit.
 
The better secured method of payment chosen, the cheaper the
cost of the transaction will be.
 
Banks have been providing various facilities to both exporters
and importers .
 
cont’d

158. 15
8
• When an exporter sells on open account basis, the exporter
might suffer cash strap, this is because he has made payment
out of his own money to deliver the goods, but has not yet
received anything in return.
cont’d

159. •
a)
•
•
Export finance may be categorized into:
Short term – to finance working capital. Short term finances
normally repaid within 18 months.
 
b) Medium term – to finance acquisition of semi­processed items.
Facilities that cover 18 to 36 months may be classified as medium­
term.
 
c) Long term – to finance the acquisition of fixed assets.
Any facility over the period of 36 months and above may be classified
as long term finance.

15
9
cont’d

160. PRE-SHIPMENT AND POST-SHIPMENT FINANCE
•
•
Pre­shipment finance is the money required to finance the
business between the commencement of the manufacturing
process or production process and the shipment of goods to the
importer
 
Post­shipment finance is money required to finance the
exporter between dispatch of goods and receipt of payment
from the importer.

161. FINANCING THE TRADE CYCLE
•
•
Growth in international trade has greatly increased over the
last century for both demand for trade finance and the degree
of sophistication with which the goods are delivered.
 
There is now a much greater choice of ‘financial engineering’
for both exporters and importers to consider when developing
an international trade strategy.

162. •
•
Organizing the finance is an important part of any well­defined
strategy and also a key contributor to the success in
international trade.
 
The availability of finance can be a major factor in securing a
new business as it provides the flexibility to offer competitive
terms to an overseas partner.
 

16
2
cont’d

163. •
a)
b)
c)
d)
e)
f)
Every facility will depend on the payment mechanism and
other criteria such as:
Customer’s requirement
Assessment of risks in the chosen facility
Terms of trade
Cost and benefit analysis of the facility
Expected income to be derived
Cross­selling of other related services
cont’d

164. UNDERSTANDING THE TRADE CYCLE
•
•
Every business cycle is unique in its own sense, even though
they might have certain elements that might be common to all
of them.
 
Each stage in the trade cycle places different demand on the
company’s finance, but the key component in the determining
the overall level of working capital required for any business is
the time taken between the start of the cycle and the receipt of
payment for the corresponding sales of the finished product.

165. •
•
The bank, through its knowledge of customer’s business, terms
of trade and its view of risks inherent a each stage of a
particular trade cycle, can structure facilities that provide
working capital for the different stages in the cycle and in
effect, directly relate to the needs of customer’s business.
 
As the bulk of international trade is undertaken on terms of
180 days or less, these facilities are important consideration for
a company engaged in exporting and importing.

16
5
cont’d

166. FACTORS THAT MAKE EXPORT FINANCING
ATTRACTIVE TO BANKS
•
a)
b)
c)
Banks considering the financing of international trade, from
the standard point of the exporter, may consider the
following:
Short Term of the Transaction – should not exceed 18
months
Self­Liquidating Nature of Business – repayment from the
sale of underlying goods
Security – the underlying goods could be used as security

167. 16
7
d)
e)
f)
Selective Nature of Business – the bank examines each
application on its merit to ensure that proper facility is
structured
 
Monitoring – trade related business is relatively easy to
monitor
 
Expected Foreign Exchange – the anticipated receipt
of foreign exchange to service its import clients.
 
cont’d

168. SHORT TERM FACILITIES AVAILABLE TO EXPORTERS
FROM BANKS
•
•
•
•
•
•
•
•
•
Export finance can be classified as traditional and non­traditional banking facilities
  TRADITIONAL  NON­TRADITIONAL
Secured/Unsecured Overdraft                                      Export Factoring
Loans (Short & Medium)                                          Invoice Discounting
Advance Against Collection                                               Forfaiting
Negotiating                                                                           Leasing
Sight Payment                                                                  Hire Purchase
Documentary Credit Acceptance                                    Counter Trade
Accommodation Finance                                               Export Merchant
Acceptance Credit                                                       Confirming House
     Avalisation

169. TRADITIONAL BANKING FACILITIES:
Overdraft
•
•
Overdraft is provided to cover borrowing of a temporary
fluctuating nature which will be repaid on the receipt of
expected funds.
 
The banks will grant an overdraft facility to finance business
requirements in both international and domestic trade.

170. 17
0
•
a)
i.
ii.
Overdrafts can be split into two categories:
Agreed Overdraft
 
 The agreed overdraft limit falls into two types:
 Short term – covers a specific requirement. Essentially, a
small bridging facility and the source and timing of the
repayment should be made clear on the onset.
 
 Renewable/Revolving – is a facility which is essentially to
be used as a standby.
cont’d

171. b) Unauthorised Overdraft Facilities
•
•
Customers are allowed to draw above the customers’ authorized
limits for a very short period.
 
For most customers, there is a level to which a bank would be
prepared to allow an overdraft without insisting on a formal
arrangement.

172. 17
2
•
•
The appearance of an excess over an unadvised limit for more
than a few days in advance of export proceeds  could indicate
impending problems.
 
Any excess over an unadvised limit should lead to a review of
the customer’s account to ensure that the assumptions on which
the original limit was marked have not changed.
cont’d

173. Short Term and Medium Term Loan
•
•
Banks provide both short and medium term loans for
exporters to purchase equipment, construction of irrigation,
and others.
 
These loans are granted both in local and foreign currencies.
Interest rates on the foreign currency loans are either the
base rate or the prime rate prevailing plus a margin.

174. •
•
•
a) Bill Advances
This method of obtaining payment will be used by an exporter
who requires greater protection than is provided by open
account method of payment.
 
After shipment of goods, there can be a considerable time lag
before the exporter receives payment.
 
The exporter submits collection documents to his bankers and
receives an advance against the documents submitted.

17
4
cont’d

175. •
•
•
•
The lending will be made with full recourse on the exporter, who
will be made to pay any dishonoured bills plus cost and charges.
 
The advances can be made either against individual bills or a
portfolio of bills.
 
A letter of hypothecation pledging the bills as security would be
required in the granting of such a facility.
 
Although there will be recourse to the exporter the primary source
of repayment will be payment of the bills by the overseas buyer.

17
5
cont’d

176. •
•
•
•
b) Bills Negotiation
Bills negotiation facility differs from an advance against bills held for
collection in that, rather than a set percentage of a bill being advanced,
the lending banker in effect buys or purchases the bill at face value less
a discount to cover interest, cost and commission.
 
The holder of a bill becomes the holder for value, for having given
consideration by purchasing the bills involved.
 
This is, in effect, a 100% lending against the value of the bill.
 
The lender retains full recourse against the exporter if the bill is
dishonoured.
cont’d

177. i.
ii.
iii.
iv.
v.
vi.
vii.
The basic considerations under the Negotiation facility will be:
 Credit Standing of the exporter
 Exporter’s proven track record
 Ability to get full control over goods through the
documentation
Marketing of the goods
 Existence of exchange control in the importer’s country
 Whether credit is held
 Terms of Payment (i.e. D/A or D.P.)
cont’d

178. Acceptance Credit or Accommodation
Finance
•
•
This facility is where the exporter’s bank allows the exporter
to draw a bill of exchange on the bank itself and the bank
accepts that bill of exchange so the exporter can discount it in
the money market at a fine rate.
 
As a security, the exporter’s bank obtains authority to take over
all rights to documentary collection, which it submits on the
exporter’s behalf.

179. 17
9
•
•
The repayment of the acceptance facility will be from the
expected export proceeds under the documentary collection.
 
Such a facility is granted to an undoubted customer with a
proven track record.
cont’d

180. Facilities Available Under Documentary Credits
•
•
•
a) Negotiation of Bills of Exchange Drawn Under     Documentary
Credit:
This facility is provided under documentary credit, where a bill of
exchange drawn on the issuing or confirming bank is purchased and
credited to the customer’s current account.
 
By negotiating, the issuing or confirming bank is, in fact, buying the bill
of exchange under the documentary credit from the exporter and
therefore, collects the export proceeds in its own name.
 
Provided the terms and conditions of the documentary credits are
complied with, the issuing bank will reimburse any bank called upon to
negotiate.

181. •
•
•
b) Discounting of Bills of Exchange Drawn Under
Documentary Credits
When the documentary credit calls for a bill of exchange with
tenor or term payment, the nominated bank designated as the
accepting bank will accept the tenor bill and, once the bill is
accepted, it becomes an eligible bill.
 
The exporter may be able to discount the bill in the money market.
 
The exporter should remember that it may be that it may be
possible to convince the importer to pay for the cost of discounting
the bills of exchange drawn under documentary credit.18
1
cont’d

182. •
•
i.
ii.
•
c) Assignment of Proceeds of a Documentary Credit
This is a means of obtaining pre­shipment finance with the
cooperation of the exporter’s bank.
 
The exporter’s bank, acting on its customer’s authority, issues a letter
of comfort to the exporter’s local supplier indicating:
 that the exporter is the beneficiary of a documentary credit
 that the bank is authorized to pay over, direct to the supplier,
certain sum from the proceeds of the credit when received.
 
 This letter of comfort may persuade the exporter’s local suppliers to
grant pre­shipment and post­shipment credit to the exporter.
cont’d

183. Red Clause Documentary Credit
•
•
A red clause documentary credit contains an instructions from
the issuing bank for the advising bank to make an advance to
the beneficiary prior to shipment.
 
When the exporter subsequently presents the shipping
documents, the amount of advance and interest will be
deducted from the full amount of the credit.
 

184. •
i.
ii.
•
The advance can be in two forms:
 Conditional, whereby the beneficiary must sign an
undertaking to use the money to help him assemble the goods
referred to in the credit.
 Unconditional, whereby the beneficiary merely signs a
receipt for money
 
In either case, the bank will be responsible for reimbursing the
advising bank if the exporter should subsequently fail to
present the documents called for under the credit.
18
4
cont’d

185. Green Clause Credit
•
•
Green clause credit contains an instruction from the issuing
bank authorizing the advising bank or nominated or confirming
bank to make advance against goods that have been
warehoused and inspected by a third party against a simple
receipt.
 
In all cases, the goods will be inspected by the third party
inspection company ensuring that goods have been properly
stored and warehoused in an approved or recommended
warehouse before payment is made to the beneficiary against a
simple receipt.

186. 18
6
•
•
Beneficiary on the presentation of the receipt issued by the
third party to the nominated or advising or confirming bank
will be granted advance against the shipping document.
 
The issuing bank will reimburse the advising or nominated or
confirming bank for the amount advanced to the beneficiary.
cont’d

187. Documentary Acceptance Credit
•
•
Documentary acceptance is a facility where the exporter draws a
bill of exchange on the issuing, advising or nominated bank, which
accepts that bill and has the bill subsequently discounted and the
proceeds credited to the exporter’s account.
 
An eligible bank bill can be discounted at a finer rate.

188. 18
8
•
•
This form of finance is sometimes called Accommodation
finance because the bills are accepted by first class banks.
 
The use of acceptance credits has expanded considerably since
the operations of the discount houses in Ghana began in the
mid nineteen eighties.
cont’d

189. NON-TRADITIONAL BANKING FACILITIES:
Factoring
•
•
•
Export factoring is the purchasing of book debts of company
or business concern for immediate cash by a factor company.
 
An export factoring service is particularly suited to business
conducted to an open account and improves the cash flows, as
well as savings.
 
Under export factoring, a customer’s entire turnover is
purchased with or without recourse.

190. •
i.
ii.
iii.
The export factoring services are as follows:
 Accounting, credit checking and debt collection
 Credit insurance against bad debts
 The provision of immediate cash against client invoices up
to 75% to 85% of face value.

19
0
cont’d

191. a)
b)
c)
Benefits of Export Factoring­Customer
Cash­flow is more predictable because the client knows
that he can claim up to 85% as immediate  advance against
his invoices
 
Bad debt losses are eliminated from those debts that have
been factored
 
Sales ledger administration is reduced because sales ledger
accounting cost is taken off
cont’d

192. f)
•
d) Foreign exchange risk may be eliminated if invoices are quoted in
foreign currencies
 
e) Management’s time is used efficiently because they can
concentrate on production and sales
 
Debtors settle indebtedness more quickly because the factor is
more efficient at collecting debt.
Some clients use the factor for this reason and do not utilize the
right to advance against the invoice.

19
2
cont’d

193. Invoice Discounting
•
•
•
Invoice discounting is an arrangement where the business
concern collects the debts which have been discounted by
financial institutions.
 
The facility is provided by a financial institution when an
exporter’s invoices are discounted and immediate cash paid to
the exporter.
 
On receipt of the funds, they are transferred to the financial
institutions that discounted the invoices.

194. a)
b)
c)
d)
Benefits of Invoice Discounting
Invoice discounting is not disclosed to the debtors of the factor
client
 
Under invoice discounting, the client does not run his own
accounts ledger
 
This facility is useful when the client has an efficient sale ledger
team of his own
 
Cash flow is improved and management could concentrate  on
production.
19
4
cont’d

195. Forfaiting
•
•
•
•
The term forfaiting is derived from a French word ‘forfait which
means to surrender or relinquish the right to something.
 
Forfaiting can be defined as the discounting of short, medium to
long term trade debt without recourse to the importer.
 
Forfaiting provides finance to exporters of semi­consumable goods,
semi­capital, plant and machinery and capital goods.
 
Exporters of all sizes have discounted the benefits of securing
payment by using bills of exchange as debt instrument, accepted by
the importer and available to the importer’s bank.

196. a)
b)
c)
Advantages to the Exporter
The exporter is freed from the liabilities of debts owed by the
buyer in the immediate future and also the contingent liabilities
which are payable by the foreign buyer.
 
The exporter’s liquidity and cashflow are improved because he
receives cash at once.
 
Enhances the customer’s borrowing capacity.
19
6
cont’d

197. a)
b)
c)
Disadvantages to the Exporter
Costs can be high and there is no interest rate subsidy
 
It may be difficult to find an institution which will be
prepared to guarantee the importer’s liabilities
 
There is possibility that the government of the buyer’s
country may impose foreign exchange controls

cont’d

198. Leasing
•
•
Leasing company buys the equipment or plant and
machinery outright from the supplier and then leases them to
the ultimate user, who has the use of the equipment or
machine for an agreed period, subject to payment of the
agreed rent to the lessor.
 
Leasing arrangement enables a user to have equipment or
machines without first having to pay for the full cost and
instead pays for it over the equipment’s life.

199. •
a)
b)
•
Leasing can be made available to the foreign buyer:
either by arranging finance from the exporter’s country into the
lessee’s country (cross­border leasing)
by arranging the leasing in the buyer’s country through an
international contract of a leasing company in the exporter’s
country.
 
The first method is more suited to major and capital intensive
equipment and machines, whilst the second approach is more
convenient to items with lower value. i.e. office equipment.
19
9
cont’d

200. a)
b)
c)
The advantages of the second method:
 Leasing could be arranged for the delivered cost of the 
equipment or plant.
 The terms of the lease might be longer than a cross border
leasing.
 The lessee will not be exposed to any foreign exchange risks
 
  *The type of lease involved in such an arrangement will be a
finance lease
cont’d

201. 20
1
a)
b)
c)
d)
Benefits of Leasing to the Exporter
Being able to use equipment without necessarily owning the
asset.
 
Leasing charges affect the profitability and cash flow without
affecting the company’s gearing ratio.
 
Enhances the exporter’s chances of company’s borrowing
capacity.
 
There is no recourse unless the exporter defaults on the contract.
cont’d

202. 20
2
a)
b)
c)
Disadvantages of Leasing to the Exporter
Leasing charges could be very expensive.
 
It may be difficult to find a leasing company which will be
prepared to do Cross Border leasing.
 
There could be tax implication for the leasing company.
cont’d

203. Hire Purchase
•
•
i.
ii.
Hire purchase agreement is similar to the leasing except that
ownership of the asset passes to the hirer.
 
Hire purchase can be organized in one of two ways:
By an arrangement with the hire purchase company in the
exporter’s country which has a branch office in the buyer’s
company.
By an arrangement with a hire purchase company in the
exporter’s country which is a member of the International
Purchase Credit Union.

204. •
•
Under hire purchase agreement, the exporter will receive
payment immediately from the hire purchase company.
 
The buyer, on the other hand, has the use of equipment or
machine and is able to pay for it by instalments with only a low
initial cash deposit.

20
4
cont’d

205. Avalisation – Avalised Bills Facility
•
•
•
Avalisation involves adding the lender’s name to a bill or
promissory note on behalf of the drawee, giving the effect of
guaranteeing payment.
 
An importer is, therefore able to get his banker’s to
unconditionally guarantee a debt to an overseas supplier.
 
Avalising is mainly used when dealing with European suppliers.

206. •
•
•
Avalisation is the specific endorsement on a bill of exchange by a bank
which guarantees payment should the drawee or importer defaults on
payment of the avalised bill at maturity.
 
Lenders under such facility will wish to take a counter – indemnity
from the customer to ensure that they have a right of recourse should
the customer fail to meet the primary obligation on the bill.
 
Avalisation can help the importer to establish new trading relationship
with an overseas supplier and possibly negotiate improved terms of
payment.

20
6
cont’d

207. Counter Trade
•
•
a)
b)
c)
d)
Counter trade covers a wide range of techniques for
handling reciprocal trade.
 
The principal types of counter trade are:
 Offset: direct and indirect
 Compensation
 Buy back
 Counter­purchase
 

208. e)  Bilateral agreements using clearing accounts
f)   Switch trading
g)  Tolling
h)  Co­operation agreements
i)   Build­operative­transfer
20
8
cont’d

209. Export Merchants
•
a)
b)
•
An export merchant is a trader who:
 Buys goods in one country and sells them in another on his
own account
 Acts as an agent for a manufacturing company that wishes to
sell his goods abroad
 
The export merchant buys goods from a supplier on normal
trade credit terms and in the supplier’s own currency.
 

210. •
•
•
The supplier does not have to concern himself with the business
of exporting because this is the role assumed by the merchant.
 
The export merchant pays for the goods more quickly than
overseas buyer.
 
The export merchants thus, provide a source of fund or
financing to the exporter.

21
0
cont’d

211. Export Finance House
•
•
•
•
Export finance houses provide finance for consumer goods, semi­capital
and capital goods on a recourse basis.
 
The primary objective of the export finance house is to supply finance
on and off basis or at regular intervals.
 
The export finance house concern themselves with the production,
processing or manufacturing of items stage by stage and also arrange
promotional activities for the items being produced.
They also pay for the administrative expenses for the goods being
manufactured.

212. UNIT 7:
IMPORT FINANCING
•
•
•
•
Objectives;
 To distinguish between Buyer and Supplier Credit
 To describe the types of credit available to the importer
 To explain the specialized facility available to importers
 To help students to know the usage of Standby Letter of Credit
Facilities

213. Introduction
•
•
•
•
The time between placing an order for goods and receipt of payment, in
respect of their subsequent resale can put significant strain on an
importer’s resources.
Such a situation may require some kind of financial assistance.
 
Seasonal peaks, long transit times and lengthy credit terms may all
compound the importer’s liquidity problem, which may require bridging
up financing.
 
It is important that the finance to meet the seasonal fluctuation of the
importer’s working capital requirements be geared towards the terms
and method of pre­payment agreed between supplier and buyer.

214. Buyer and Supplier Credit
•
•
•
   Buyer credit facility
This involves a loan from a local bank (e.g. Ecobank Ghana Ltd)
to enable an overseas buyer to pay the full cash price of the export
on shipment.
 
The loan is made directly to the overseas buyer.
 
   Supplier credit
This involves the exporter’s bank lending money to the exporter, to
provide post­shipment finance.

215. TYPES OF CREDIT AVAILABLE TO THE IMPORTER
•
•
•
a)  Overdrafts
Overdrafts are provided for imports to cover borrowing of
temporary fluctuating nature and are repaid from the sale of the
imported items.
 
Overdrafts are available in local and foreign currencies, and are
simple and convenient to overdraw within an agreed facility.
 
The overdrawn account is then replenished with payment received
from the sales.
21
5

216. •
•
•
Overdrafts could also be provided to cover specific import requirements.
 
Considerations for such facilities are not granted if the bank cannot
obtain control over the source of repayment
 
Although simple and flexible, the importers may not be able to finance
all elements of import contracts from overdrafts, particularly as
borrowing in this way may be more expensive than other forms of
financing.


cont’d

217. b)  Import Loans
•
•
•
Import loans provides importers with the flexibility to take a period
of extended credit undisclosed to the seller, whilst allowing
optimum payment terms to be offered.
 
This allows the importer time to sell the goods and realize the
proceeds before having to repay the loan.
 
It is common for the underlying transaction to be settled ‘on sight’
basis, with the goods being consigned to the order of the bank.
 

218. •
•
•
By offering to settle import bills immediately, importers may be
able to negotiate better terms or prices with their suppliers.
 
Where credit is taken from the supplier, the facility can be used to
meet the importer’s obligation on the maturity date of a term bill
and provide finance for an extended period to match sales receipts.
 
Import loans usually cover individual shipments of goods and may
be arranged in both local and foreign currencies, with fixed or
variable rate to the prevailing local interest rate or base rate or
prime rate.
21
8
cont’d

219. c)  Product Loans or Warehousing Facility
•
•
•
This is a short term loan made by a bank to an importer, using the
imported goods as security.
 
The purpose of this facility is to enable the importer to pay for
goods, and he is usually expected to repay the facility from the
proceeds of the eventual sale of his goods.
 
Sometimes, importers buy goods on Document Against Payment,
or Irrevocable Letter of Credit payable at Sight Terms for resale to
a third party in the same country.

220. •Thus, the importer may require finance to bridge the gap between
sight payment and receipt of funds from the third party.

22
0
cont’d

221. PROCEDURE FOR PRODUCE LOAN
i.
ii.
iii.
The lending bank will obtain a letter of hypothecation from the
importer that incorporates a letter of pledge that the importer
accepted the loan granted against the usage of goods as security.
 
When the shipping documents are received, they will be pledged
as security to the bank.
 
The lending bank pays the bill of exchange with the instructions
as per the collection order or terms and conditions of the letter
of credit.
22
1

222. iv.
v.
The bank will debit a produce loan and credit the customer’s
current    account with the agreed amount of the advance.
 
The shipping documents would be retained by the lending bank.
The banks will arrange with its agents to have the goods
warehoused in the name of the lending bank.
 
vi.  The goods should be insured at the expense of the importer.
cont’d

223. vii.  The goods remain in the warehouse until the time comes for
delivery to the ultimate buyer.
 
viii.  The ultimate buyer pays directly to the lending bank and the
proceeds are used to clear the produce loan, including interest  and
charges.
22
3
cont’d

224. d)  Acceptance Credit facility/Accommodation Facility
•
•
•
Banker’s acceptances are facilities granted by banks to enable
importers to pay the exporters, pending the sale of goods.
 
The importer’s bank allows the exporter to draw the bill of
exchange on the bank itself and accept the bill of exchange.
 
Since this bill is a bank bill, the importer can discount it in a money
market at a finer rate to pay off the exporter.

225. •
•
As security for the lending bank, it will usually obtain authority to
take over the right of the goods.
 
Normally under such arrangement, the bank will require a letter of
hypothecation from the importer and if the documents of title or
goods are held by the importer prior to their resale, the bank will
require a Trust Receipt or Trust Letter.

22
5
cont’d

226. e)  Documentary Credit Facilities
•
•
•
When a bank issues an irrevocable documentary credit, it
conditionally guarantees a consumer’s trade debt.
 
Documentary credit represents an obligation to pay or accept
liability, provided the overseas supplier meets the terms and
conditions of the credit, including the provision of the documents
of title to the goods being shipped.
 
The bank must be satisfied with the buyer’s ability to meet the
liability on the due date, and if any doubts persist about the
importer, the full or partial cash cover should be taken from the
buyer at the time the letter of credit is issued.

227. f)  Standby Letter of Credit
•
•
•
A standby letter of credit can be used to support open account
trading.
 
It performs a similar function as a bank guarantee, but it is issued
in a format corresponding to that of a documentary credit and
governed by the Uniform Customs and Practice for Documentary
Credit and International Standby Credit Practice.
 
A standby credit is one which is issued to cover non­performance.

228. cont’d
•
•
•
It stipulates that a sum of money will be paid to the beneficiary in
the event of default or non­performance.
 
Claims on the issuing bank will be made in the form of a signed
statement, usually accompanied by sight drafts.
 
The statement certifies that an amount drawn represents and
covers the unpaid indebtedness and interest due.
22
8

229. •
•
•
•
•
Banks are prepared to provide facilities against Standby Letter of
Credit since:
 They represent a simple form of security
 They are essentially bank guarantees issued in the form of a
documentary credit
 Documentation is simple and straightforward
 No proof of non­performance is required, other than a simple
claim.
 They are subjected to UCP 600 Revision 2007 or ISP 98 ICC 590
cont’d

230. BENEFITS TO THE APPLICANT
i.
ii.
iii.
iv.
Avoids the need to transfer funds to an overseas subsidiary.
 
Enables provision of security where exchange control prohibits or
restricts transfer of funds.
 
Used to guarantee the issue of bid, performance, advance payment bonds.
 
Used to support Open Account Trade/Documentary Collection
Operations. The exporter has a Standby Credit in his favour to cover him
in the event of default by the importer.
 

231. •
•
•
In some countries like the USA, standby letter of credit may be
issued in preference to bank guarantees.
 
Provided that the applicant has agreed to be responsible for all
discount costs, this credit will meet the requirements of the
beneficiary.
 
To the importer, this facility is more attractive than open accounts
terms or documentary collection terms.

23
1
cont’d

232. UNIT 8:
METHODS OF INTERNATIONAL SETTLEMENT THROUGH
BANKS
•
•
•
•
Objectives;
 To discuss the different methods of settlement and procedures for issuing
payments instructions
 To help students to be able to identify, understand and appreciate the
different methods of settlement and procedures for issuing payment or
instructions
 To help students understand the accounting procedures for Nostro and
Vostro accounts
 To examine problems and difficulties experienced in International
Settlement

233. Introduction
•
•
•
All international trade transactions require settlement to be made
by the importer to the exporter.
 
There is, therefore, the understanding of the mechanism for
settlement, and its related problems and risks are vital.
 
Transfer of funds from one person to another overseas has its
inherent risks.

234. •
•
•
In the transfer of funds to settle a debt such as tuition fees, a
foreign exchange deal takes place.
 
Ghanaian banks may have their correspondent banks in countries
overseas with which they maintain accounts designated in the
accounts of that country.
 
These accounts are known as Nostro and Vostro.

23
4
cont’d

235. •
•
Nostro Account (Our Account With You)
This account, from the point of view of a Ghanaian bank would be
currency accounts which are maintained in its name in the bank
overseas.
 
Vostro Account (Your Account With Us)
The Vostro account of a Ghanaian bank would be the Cedi
accounts in the names of overseas banks that are maintained with it.
cont’d

236. a)  Payment by Cheque
•
•
i.
ii.
iii.
This is a method of settlement in international transactions where
the payee’s account is credited when the drawer’s bank clears the
cheque presented by the payee.
Procedure;
A U.K. buyer draws a cheque in favour of a Ghanaian exporter
and then posts the cheque to the Ghanaian exporter;
The Ghanaian will then present the cheque to his local banker,
who will in turn present it to the drawee’s bank for payment;
On receipt of funds from the buyer’s bank in the U.K., the
Ghanaian bank will credit the exporter’s foreign currency
account or foreign exchange account.

237. Disadvantages of Payment by Cheque
•
a)
b)
Payment by cheque of a debt in international trade might also be
unsatisfactory for the following reasons:
The exporter or payee will have to ask his local bankers to
arrange to collect the payment and possibly incur handling and
collection charges.
 
The cheque could be stolen or lost in the post thereby causing
delays on the part of the exporter or payee.

238. 23
8
c)   The cheque may be returned and not paid when presented.
 
d)Postal/courier services are said to be slow when one considers
the effective usage of the funds.
 
e)The cheque might contravene the exchange control regulations
of the drawee’s country therefore settlement could be delayed.
cont’d

239. b)  Payment by Banker’s Draft or International
Banker’s Draft
•
•
•
An international banker’s draft is a cheque drawn by one bank on its
correspondent bank overseas.
 
This method is particularly suitable for non­priority, low value
payments or those which are to be accompanied by documentation.
 
If the draft is in the local currency, the beneficiary will present it
through the local clearing.

240. 24
0
i.
ii.
Procedure;
Supposing that a company in Ghana wishes to pay off a supplier
in the UK for £20,000 by means of a banker’s draft, the
Ghanaian company will make a written request to his local bank
with the relevant import documents to purchase £20,000 sterling
spot or debit his foreign currency account and issue the banker’s
draft for £20,000;
 
The Ghanaian bank debits the company’s account with the cedi
equivalent plus commission or debits the foreign currency account
and gives the banker’s draft to the company’s representative;
cont’d

241. iii. The banker’s draft will be sent to the supplier in the UK;
 
iv. The supplier presents the drafts through his bankers to the
correspondent bank on whom the draft was issued and the
overseas account or Nostro account is debited accordingly.
 
 
cont’d

242. Disadvantages of Banker’s Draft
24
2
a)
b)
•
Banker’s drafts are commonly used but they are a slow method
of payment for the following reasons:
 The draft could be delayed or stolen in the post
 
 In view of high technology fraud, payee and amount of the
draft could be altered through laser technique.
 
Banker’s draft has advantages over cheques as the issuing
banks do not normally stop payment and also not returned.
 

243. 24
3
c)  The remitter is debited at the time the draft is issued, but
there is a delay before the beneficiary can pay the draft into
his account and obtain cleared funds.
cont’d

244. c)  Mail Transfer (M/T)
•
•
•
A mail transfer is a payment order in writing sent by banks to
overseas banks and can be authenticated as having been
authorized by a proper official in the sending bank in which it
instructs the overseas bank to pay a certain sum of money to a
specified beneficiary.
 
Mail transfer is a bank to bank message, unlike the banker’s
draft; and is sent by airmail.
 
Mail payment is best used only for non­priority, low value
transactions.

245. •
i.
ii.
Procedures For A Mail Transfer;
A Ghanaian firm paying for imports from a British supplier will
give a written instruction to his local bankers to issue a mail
transfer specifying the full name and address of the beneficiary
and when the payment should be made;
 
The local bank then sends instructions to its correspondent bank
in UK giving details of payment.

24
5
cont’d

246. •
•
•
•
The instruction must be capable of authentication, by means of
authorized signature books kept with the correspondent banks.
 
The UK bank will debit the account of the Ghanaian bank held by it
and pay the beneficiary
 
Under the mail transfer system, instructions received by
correspondent bank should be properly authenticated.
 
Because mail transfer involves airmail communication between one
bank and another in an overseas country, it is a quicker method of
payment than the banker’s draft at no extra cost.
cont’d

247. d)  Telegraphic/Cable Transfer
•
•
•
Telegraphic transfers or cable payment orders are payment
instructions sent by telex or cable.
 
It is faster but slightly more expensive than mail transfers.
 
All telegraphic payment instructions are authenticated by Test
Code which the correspondent banks use to verify the identity of
the sender of the message and also verify the amount and currency
to be paid to the specified beneficiary.
24
7

248. e)  SWIFT (Society For Worldwide Interbank
Financial Telecommunications)
•
•
This is a co­operative society of member banks which has
established a computerized international communications network
to improve the administrative efficiency of the banks and also to
speed up international payment and transfers among member
banks.
 
This improvement is achieved by using the computer systems of
the member banks, which are linked by international
telecommunication lines.

249. •
•
•
SWIFT has an inbuilt mechanism for coding and decoding
payment instructions or authenticating messages, which makes it
very secure and reduces fraud to the barest minimum.
 
It is a very fast method of settlement cost effective.
 
Payment is usually effected for value within two business days.

24
9
cont’d

250. •
•
•
•
More banks internationally have joined SWIFT, making the use of
mail transfers and telegraphic transfers less favourable because of
its safety and security.
 
A SWIFT message is a payment equivalent to mail transfer.
 
The paying bank and corresponding bank overseas are both
members of SWIFT.
 
‘Urgent’ SWIFT message is a payment equivalent to one by
telegraphic transfer.
cont’d

251. f)  International Money Order
•
•
•
•
International money order is a means of transferring a
comparatively small sum of money from one country to another
through the agency of the post office.
 
Since only small amounts are involved, international money orders
ae best suited to small export sales orders.
 
In the case where the exporter asks payment in advance, the
amount would perhaps not financially justify allowing credit to the
importer or buyer.
Payment under this mechanism are non­priority.

252. ACCOUNTING PROCEDURES FOR MAKING
SETTLEMENTS
•
•
All international trading transactions require a settlement to be
made between importer and exporter.
 
The transfer of funds from one person in one country to another is
made possible because all the major banks have their
correspondent banks in countries overseas with whom they
maintain accounts.
 

253. Nostro and Vostro Accounts
•
•
  Nostro Accounts
From the viewpoint of a local bank, its Nostro accounts are those
currency accounts maintained in its name in the books of an
overseas or correspondent bank.
 
For example, if Standard Chartered Bank Ghana Limited has an
account in pounds sterling with Standard Chartered Bank UK,
then that account is a Nostro account for Stanchart Ghana.

254. 25
4
•
•
  Vostro Accounts
The Vostro accounts are those local currency accounts maintained
locally for the overseas or correspondent bank.
 
If Stanchart PLC London maintains a cedi account with Stanchart
Ghana Ltd, then the account is a Vostro account for Stanchart
PLC London.
cont’d

255. Book­keeping for Transfer of Funds
•
i.
ii.
When a local bank customer wishes to transfer funds denominated
in foreign currency, the booking is:
Debit the customer with the cedi equivalent, plus charges, of the
required amount and credit the currency to the nostro account. If
the Ghanaian customer maintains a foreign currency account,
then the appropriate currency amount will be debited to that
account and credit the nostro account.
 
Advise the overseas bank that it can debit the nostro with the
requisite amount of currency and credit the funds to the account
of the beneficiary.

256. Controlling the Balances on Nostro Accounts
•
•
•
•
A nostro account earns a little interest and as such banks may not allow
its balance on the account to grow unnecessarily large.
 
At the same time, the banks must keep enough funds in the account to
meet all payment requests.
 
Trading in currencies could be a profitable business if operators avoid
an excessively large balance on the nostro account.
 
A foreign Exchange Dealer or Treasurer should always match receipts
and payments in the foreign currency.

257. •
i.
ii.
iii.
To exercise good control over nostro, a bank must obviously keep a
careful record of its transaction;
Items passing through the nostro accounts should be value­dated
items.
 
Periodic statements should be sent to enable the overseas banks
reconcile promptly.
 
For each liability (Banker’s draft or Mail Transfer), the date on
which it is expected that the nostro account will actually be debited
with the payment should be monitored.
cont’d

258. International Cash Management Facilities
(Global Electronic Banking System)
•
•
•
In addition to SWIFT facilities, international banks provide
international cash management facilities to their correspondent
banking networks through computer modems.
 
These facilities put the correspondent banks in complete control of
their nostro balances.
 
With desktop access to bank accounts, comprehensive balance
transaction reports, key financial market information can be obtained
within a relatively short time for effective cash management.

259. •
•
Banks with a significant number of international payments to make
could benefit from operational efficiencies provided by delivery
payment instructions to correspondent bank electronically via
computer modems.
 
Such facilities could be recommended to Banks in Ghana with
smaller capital outlay, which could not afford to pay for SWIFT
facilities.

25
9
cont’d

260. Features
a)
b)
c)
d)
Some of the features on these systems  are:
 24 hour/365 day access to balances and transaction details on
foreign currency accounts held anywhere in the group.
 
 Provision of L/C facilities – L/C facilities can be created
quickly from pre­stored templates and libraries of data
customized to specific needs.
 
 Fast movement of funds between accounts
 
 Current and projected cashflow reporting

261. e)  Comprehensive search facilities
 
f)   Extensive balance history information
 
g)  Customized reporting and download of information to software packages
 
h)  Global Exchange rates and interest information
 
i)   Up­to­date reports on World Economies and financial markets

26
1
cont’d

262. General Problems Associated with International
Fund Transfers
•
•
•
With foreign exchange liberalization in the country since 1988, and
the opening of forex bureau and money transfer agencies such as
Western Union, MoneyGram, Vigo and others, the impact of
money laundry cannot be easily discounted.
 
Money laundering enables funds or money derived from criminal
activities to be ‘cleaned’ so that they could be used with impunity
by criminals.
 
Many banks do not have compliance offices to deal with such
illegal transfers.

263. Features of Money Laundering Business
a)
•
Large amounts going abroad from a relatively new account,
which is fed by many small accounts coming in.
Obviously, there may be legitimate reasons for the transactions but,
where the account is new, its proprietors are not well known and its
business not too clear, it may be well worth a reference to the
compliance office.
 
b)   Attempt to transfer money in contravention of internationally
agreed sanctions.
26
3

264. c)
d)
Stealing and transferring state funds into private accounts
overseas by public and state officials.
 
Transfers that would contravene the laws of other countries. For
example, payments for export which the exporter’s government
hasbanned by law.
 
e)  Requests for customers to pass message to overseas businesses,
usually by means of telex
cont’d

265. Value Dating of Fund Transfers
•
•
•
•
Time differences between countries affect payment of monies.
 
Delays due to complexities like early cut off times.
 
Statutory or religious holidays will inevitably delay the receipt of
funds by a beneficiary.
 
Banks need to draw their own internal policies on money
laundering, especially detecting transfers marked different from
their normal line of business or for unusually large amounts.

266. •
•
•
•
Forged banker’s drafts and fraudulent foreign cheques have seen a
marked increase.
 
Another problem noted in international settlement has been the
usage of foreign cheques.
 
From the beneficiary’s point of view, there is no guarantee that the
foreign cheque presented will be honoured.
 
In some countries, sending foreign cheques may be contravening
the exchange control regulation of the buyer’s government.
26
6
cont’d

267. Know Your Customer (KYC) Policy
•
•
•
To reduce money laundering activities, banks worldwide have
adopted detailed and comprehensive ‘Know Your Customer’
policies.
 
Under KYC, every financial transaction is monitored and all
banking activities would require identification.
 
The pretext for KYC requirements is detecting illegal money
transfer..
 

268. •
•
Banks are also required to determine the source of customer
deposit, monitor customer banking activities to detect deviations.
 
The cornerstone of KYC is based on customer identification and
record keeping and as such, banks must identify, verify and
confirm the business transactions of their customers as part of their
due diligence processes.

26
8
cont’d

269. UNIT 9:
EXCHANGE RATES/FOREIGN
EXCHANGE MARKETS

270. FOREIGN EXCHANGE MARKETS
•
a)
b)
c)
The forex markets provide the physical and institutional
structure through which;
Currencies are exchanged
Currency rates are determined
Currency transactions are physically completed

271. What is a Foreign Exchange Transaction?
•A foreign exchange transaction is an agreement
between a buyer and a seller that a fixed amount of one
currency will be delivered for some fixed amount of
other currency at a specified rate.

272. Characteristics of Forex Markets
•There are six (6) main characteristics of the forex
markets:

1) The geographical extent – the forex market spans the
globe. Major trading starts in Sydney and Tokyo moves
west to Hong Kong and Singapore then to Bahrain and
the main European markets of Frankfurt, Zurich and
London.

273. Cont’d
•
•
Trading then jumps the Atlantic to U.S.A (New York,
West Chicago and ends in San Francisco and Los
Angeles).

Reuters, Telerate and Bloomberg are the leading
suppliers of forex rate information and trading system.

274. Cont’d
i.
2) Main Functions of the Forex Market:
The forex market is the mechanism by which
participants;
Transfer purchasing power between countries
(because international trade and capital transaction
normally involve parties in different countries who
want to use their own currencies)

275. Cont’d
ii. Obtain or provide credit for international trade
transactions (bankers acceptance and letters of credit
are the main instruments used)

iii.Forex markets provide hedging facilities for
transferring foreign exchange risk to someone willing to
carry the risk (minimise exposure to exchange rate risk)

276. Cont’d
i.
•
•
3) Market Participants:
The forex market has five broad categories of
participants:
Bank and non-bank foreign exchange dealers

Market makers quote bid and ask prices

They profit from buying at a bid price and reselling at a
slightly higher ask (also called offer) price---bid-ask
spread.

277. Cont’d
•Currency trading is profitable and often contributes
between 10%-20% to average net income of major U.S
currency trading commercial and investment banks.

278. Cont’d
•
•
ii. Individuals and firms conducting transactions
Importers, exporters, portfolio investors, multinational
enterprises (MNE’s), tourists, and others use the FOREX
market.

Transactions may have commercial, investment, or
hedging motives.

279. Cont’d
•
•
•
iii. Speculators and Arbitragers
They seek profit from trading in the market itself, trying to
profit from simultaneous differences in exchange rates in
different markets.

They normally operate in their own interest without a need
or obligation to serve clients.

Speculators seek all of their profits from exchange rate
changes, in contrast to dealers who seek profit from bid-ask
spread as well as exchange rate changes

280. Cont’d
•
•
Recently speculators are employed by major banks and
trade for the banks account.

Thus bank act as both dealers and speculators or
arbitragers

281. Cont’d
•
•
•
iv. Central Banks and Treasuries
They use the FOREX market to acquire or spend their country’s
currency reserves as well as influence the price at which their
own currency trades.

They may act to support the value of their own currency
because of national policies or because of commitments
entered into through memberships in joint float agreements,
such as European Monetary System(EMS).

Foremost objective is to influence the foreign exchange value of
their currency in a manner that will benefit the interest of their
citizens.

282. Cont’d
•
•
•
v. Foreign Exchange Brokers
(Agents who facilitate trading between dealers without
becoming principals in the transaction).

They are paid a small commission.

They are highly networked and know the markets

283. Cont’d
•
•
4) Daily Transaction Volume
The U.K plays a major role in foreign exchange activity,
accounting for 40.9% of the global market in 2013
9compared with 18.9% for the U.S.A).

According to the Bank for International settlements
(2015) the daily turnover for the year to April 2015 was
$5.34tn, with $2.04tn in spot transactions and $3.3tn in
forward and derivative- based transactions.

284. Cont’d
•
•
5) The Spot, Forward and Swap Transactions:
Transaction in the forex market can be executed on a spot,
forward or swap basis.
i. Types of Transactions
A spot transaction requires almost immediate delivery of
foreign exchange, e.g delivery and payment on the second
following business day.

A forward transaction requires delivery of foreign
exchange at some future date.

285. Cont’d
•
•
A swap transaction in the interbank market/forex
market is really a combination of spot and forward
transactions (i.e. spot forward or forward-forward swap).

ii. The Nature of Swap Transactions
It is the simultaneous purchase and sale of a given
amount of foreign exchange for two different value
dates with the same counter party.

286. Cont’d
•
•
Spot-Forward Swap:
The dealer buys a currency in the spot market and
simultaneously sells the same amount back to the
same bank in the forward market.

Forward-forward swap(more sophisticated swap):
The dealer sells £20,000,000 forward for dollars for
delivery in two months at $1.8420/£ and buys £20,000,
000 forward for delivery in three months at $1.8400/£.

287. Cont’d
•
•
•
6) Quotation systems
Most foreign exchange transactions are through the U.S
dollar.

A foreign exchange quote is a statement of willingness
to buy or sell at an announced rate. It is the price of one
currency expressed in terms of another currency.

Interbank Quotes – Professional dealers or brokers may
state quote in one of 2 ways:

288. Cont’d
a)
•
European Terms: Foreign currency price of one U.S
dollar. For example, Sfr 1.600/$, read as 1.6000
Swiss Francs per dollar.

b) American Terms: Dollar price of a unit of foreign
currency e.g. $0.6250/Sfr, read as 0.6250 dollars per
Swiss Francs.
Most interbank quotations/quotes are stated in
European terms.

289. The Eurocurrency Markets
•
•
1.
2.
Eurocurrencies are domestic currencies on deposit in a
second country. Any convertible (exchangeable)
currency can exist in ‘Euro’ form.

Eurocurrency markets serve two valuable purposes.
They are an efficient and convenient money market
device for holding excess corporate liquidity.

This market is a major source of short-term bank
loans to finance corporate working capital needs.

290. Eurocurrency interest rate
•
•
•
In the eurocurrency market, the reference interest rate
is LIBOR – The London Interbank Offered Rate, LIBOR
has become the benchmark short interest rate.

It is defined by the British Bankers Association.

Visit them on http://www.bba.org.uk.

291. Cont’d
•
•
The U.S dollar LIBOR is the mean of 16 multinational
banks interbank offered rates sampled mid day in
London.

Yen LIBOR, Euro Libor and all other Libor rates are
calculated the same way.

292. 


Exchange rate and interest rate risk management are of key
importance to companies that operate internationally or use
debt finance.

Many currencies now float freely against each other and
exchange rates can be volatile as a result.

Ghana for instance, has been using a floating exchange rate
regime for sometime now.

293. 
Question. When did Ghana start using the floating exchange rate regime?
Question. Name some companies in Ghana that operate internationally.
 
Under this topic, we shall consider the different types of interest rate
and exchange rate risk that are faced by companies and the
techniques available to control and manage such risk, including the
use of derivative instruments.

294. INTEREST AND EXCHANGE RATE RISK


Introduction:
In recent years, many companies have seen the potential benefits of
managing or hedging their interest and exchange rate risk exposures.

The importance of hedging to companies depends largely on the
scale or magnitude of the potential losses that may result from
unfavorable movements in interest and exchange rates.

295. 

With interest rate exposures, the magnitude of such losses depends
on the volatility of interest rates, the level of companies’ gearing and
the proportion of floating rate corporate debt.

One of the easiest ways to understand interest and exchange rate
management is to see them as a form of insurance whereby
companies insure themselves against adverse exchange and interest
rate movements……..

296. 
….. in the same way that we as human beings insure ourselves
against personal injury or loss of personal possessions.


INTEREST RATE AND INTEREST RATE RISK
Interest rate on loan finance may be either floating or fixed.
a) A floating interest rate means that the rate of return
payable to lenders will rise and fall with market rates of
interest.

297. 


The converse will normally be true for loans and debentures with fixed
interest rates.

Movements in interest rates can be a significant issue for a business
that has high levels of borrowing.

A business with a floating rate of interest may find that interest rate
rises will place real strains on cash flows and profitability.

298. 


Conversely, a business that has a fixed rate of interest will find that,
when interest rates are falling, it will not enjoy the benefit of lower
interest charges.

To reduce or eliminate these risks, a business may enter into a
hedging agreement.

This is an attempt to reduce or eliminate risk by taking some form
of counter reaction.

299. TYPES OF INTEREST RATE RISK

1.


Basis Risk
A company may have Assets and liabilities of similar sizes,
both with floating interest rates, and so will both receive
interest and pay interest.

At first sight, it may not appear to have any interest rate risk
exposure.

300. 


However, if the two interest rates are not determined using the same
basis (e.g. One is linked to LIBOR but the other is not), it is unlikely
that they will move perfectly in line with each other.

As one rate increases, the other rate might change by a different
amount.

2. Gap Exposure
A company may have assets and liabilities which are
matched in terms of ………..

301. 
…… size and the floating interest rates are also determined on the
same basis, e.g.by LIBOR.

It is still possible for interest rate risk to exist as the rate on
loans may be revised on a quarterly basis; where as the rates
on Assets may be revised on a monthly basis.

302. EXCHANGE RATES




An exchange rate is the price of one currency expressed in terms of
another.

Therefore if the exchange rate between the US Dollar and the Pound
is US$1.44 = £1.00, this means that £1.00 will cost US$1.44.

Taking the reciprocal, US$1.00 will cost 69.44 pence.

303. 



Also if the exchange rate between the Ghana cedi and the British
pound is Gh¢2.25=£1, this means that £1 will cost Gh¢2.25.

Taking the reciprocal, Gh¢1 will cost 44.44pence.

Besides, if the exchange rate between the Ghana cedi and the U.S
dollar is Gh¢1.45=US$1.00, this means that, US$1 will cost
Gh¢1.45.

Taking the reciprocal, Gh¢1 will cost 68.96cent.

304. 


The standardized forms of expression are:

-US$/£: 1.44, Gh¢/£:2.25, Gh¢/US$:1.45
Or Or Or
-US$1.44/£, Gh¢2.25/£, Gh¢1.45/US$

Exchange rates are expressed in terms of the number of units of the first
currency per single unit of the second currency.

Also forex rates are normally given to five or six significant figures.

So for the US$/£ exchange rate on 16
th August 2001, the more accurate rate is
US$1.4431/£

305. 

Currency exchange rates are given as a rate which you can buy the
first currency (bid rate) and a rate at which you can sell the first
currency (offer rate).

In the case of the US$/£ exchange rate, the market rates on 16
th
August 2001 were:
(Buy rate) (Sell rate)
Bid Rate Offer Rate
US$/£ 1.4430 1.4432

306. You can buy dollars from a You can sell dollars to a bank or broker
Bank/broker at this rate at this rate
Or or
The number of dollars The number of dollars you have
receive for giving up one pond. to give up to receive one pond.

1). So if you wished to sell US$1million you would receive:

$1000, 000 = £692,905
1.4432
2). However, if you wish to purchase US$1million, the cost would be:
$1000, 000 = £693,001
1.4430

307. 


HOW DO FOREIGN CURRENCY DEALERS MAKE PROFIT?

The foreign exchange dealers make profit in two ways.

Firstly, they may charge commission on a deal, depending on the
size of the transaction, this can vary, but it is generally well below
1%.

Secondly, these institutions are dealing with numerous buyers
and sellers everyday and they make a profit on the difference
between the bid price and offer price (the bid/ offer spread).

308. 

In the above example, if a dealer sold US$1million and bought
US$1million with a bid offer spread of 0.02 of a cent, a profit of £693,
001 - £692,905 = £96 is made

CLASSWORK/ ASSIGNMENT
Answer the following questions on the basis that the euro/US$
exchange rate is 1.1168 – 1.1173

a) What is the cost of buying 200,000 Euros?
b) How much would it cost to purchase US$4million?
c) How many dollars would be received from selling 800,000 Euros?
d)How many Euros would be received from selling US$240,000?

309. Answers:
1)200,000 = US$179,083
1.1168

2) 4000, 0000 × 1.1173 = €4,469,200

3) 800,000 = US$ 716,012
1.1173

4) 240,000 ×1.1168 = € 268,032

310. THE SPOT AND THE FORWARD EXCHANGE MARKETS




a) THE SPOT MARKET
In the spot market, transactions take place which are to be settled
quickly. Officially, this is described as immediate delivery, but this
usually takes place two business days after the deal is struck.

The spot rate refers to the rate of exchange if buying or selling the currency
immediately. The higher of the spot rates is the buy rate or offer rate,
whereas the lower spot rate is the sell rate or bid rate.
 
The difference between the two spot rates is called the spread.

311. 


b) THE FORWARD MARKET
In the forward market, a deal is arranged to exchange currency at
some future date at a price agreed now.

The periods of time are generally one, three or six months, but it is
possible to arrange an exchange of currencies at a predetermined rate
many years from now.

Forward transactions represent about one third to one half of all forex
deals.

312. 


There are many currencies, however, for which forward quotes are
difficult to obtain.

The so-called exotic currencies generally do not have forward rates
quoted by dealers.

On the other hand spot markets exist for most of the world’s
currencies e.g. Dollar, Pound Sterling, Euro’s, Hong Kong Dollar,
Singaporean Dollar, South African Rand, Japanese Yen, Canadian
Dollar, Kroner etc.

313. TYPES OF EXCHANGE RATE RISK



1… TRANSACTION RISK
Companies expect either to pay or to receive amounts of foreign
currency in the future as a result of either importing or exporting
raw materials, goods or services.

Example: Consider a UK company which sells a car to a German
customer for €22,000 and gives 3 months credit, with payment to be
received in Euros.

314. 



The current spot rate is €1.434/£, so the company expects to receive
€22000 = £ 15,342
1.434

Now 3 months later the pound appreciates against Euro at a spot rate of
€1.496/£.

This means that £1 which exchanged for €1.434,
3 months earlier will now exchange for €1.496.

The UK Company should now expect to receive
22,000 =£14,706
1.496

315. 


Transaction risk is the risk that the amount of domestic currency
either paid or received in foreign currency transactions may change
due to movements in the exchange rate.

Companies expecting to receive foreign currency in the future will
therefore be concerned about the domestic currency appreciating
against the foreign currency.

Companies expecting to pay foreign currency in the future are
concerned about the possibility of the domestic currency
depreciating against the foreign currency.

316. 



Ghanaian Example:
A Ghanaian company exports to a Liberian company and expects to
receive Lib$500,000

Ghanaian company gives 3 months credit

Current spot rate is Lib$2.25211/Gh¢

Ghanaian company , therefore has in mind:

500,000 = GH¢198, 326.1
2.5211

317. 


Ghanaian example cont.

In 3months, Cedi appreciates against Liberian dollar and new spot
rate is Lib$2.7000/Gh¢

One Gh¢ was worth $2.5211 is now worth Lib$2.7

Ghanaian exporter should now expect.
500,000 = 185,185.18
2.7000

318. 


CONCLUSION:

When Domestic currency (e.g. cedis) appreciates, Ghanaian
exporters will lose.

However importers who have to pay foreign currency will gain
because they will need fewer cedis.

When Domestic currency depreciates, exporters will gain and
importers will lose because importers will have to pay more cedis
for the same quantity of foreign currency.

319. 2… TRANSLATION RISK




Translation risk arises because financial data denominated in one
currency are then expressed in terms of another currency.

Between two accounting dates, the figures can be affected by
exchange –rate movement’s greatly distorting comparability.

The financial statements of overseas units are usually translated
into the home currency in order that they might be consolidated
with the group’s financial statements.

320. 
a)

Translation risk refers to the possibility that, as a result of the
translation of overseas assets, liabilities and profits into the
domestic currency, the holding company may experience a loss or
gain due to exchange rate movements.

THERE ARE TWO ELEMENTS TO TRANSLATION RISK:
The Balance Sheet effects:

Assets and liabilities denominated in a foreign currency can
fluctuate in value in home currency terms with forex market changes.

321. 
For example: if a UK Company acquires Gh¢1, 000,000 of Assets
in Ghana when the rate of exchange is GH¢2.2/£, this can go
into the UK group’s accounts at a value of £454,545.

If over the course of the next year, the Ghanaian cedi falls
against the sterling to GH¢2.7/£, when the consolidated
accounts are drawn up and the asset is translated at the current
exchange rate at the end of the year, it is valued at only £370,370
(1000, 000/2.7), a ‘loss’ of £84,175. And yet, the asset has not
changed in value in GHc terms not jot.

322. 

b) The profit and loss account effect

Currency changes can have an adverse impact on the group’s profits
because of the translation of foreign subsidiaries’ profits.

This often occurs even though the subsidiaries managers are
performing well and increasing profit in terms of the currency in
which they operate.

323. 3… ECONOMIC RISK




A company’s economic value may decline as a result of forex
movements causing a loss in Competitive strength.

The worth of a company is the discounted cash flows payable to
the owners.

Economic risk refers to the risk of long term movements in
exchange rates undermining the international competitiveness of a
company or reducing the net present value of its business
operations.

324. 

Two ways in which competitive position can be undermined by
forex changes.

a)Directly
If your firm’s home currency strengthens, then foreign competitors
are able to gain sales and profits at your expense because your
products are more expensive (or you have reduced margins) in the
eyes of customers both abroad and at home.

325. b) Indirectly




Even if your home currency does not move adversely vis -a - vis
your customer’s currency, you can lose competitive position.

For example, suppose a Ghanaian firm is selling into Hong Kong
and its main competitor is a New Zealand firm.

If the New Zealand dollar weakens against the Hong Kong dollar,
the Ghanaian firm has lost some competitive position.

326. MANAGEMENT OF INTEREST RATE & EXCHANGE RATE
RISKS
a)Internal Management of Interest rate risk

b) Internal Management of Exchange rate risk

327. INTERNAL MANAGEMENT OF INTEREST RATE RISK

•

There are 2 general methods of internal hedging that can be
used to manage interest rate exposure within a company’s
balance sheet.

Smoothing:
This is where a company maintains a balance between its fixed
rate and floating rate borrowing.
…..

328. 

If interest rates rise, the disadvantage of the relatively expensive
floating rate loan will be cancelled out by the less expensive
fixed rate loan.

If interest rates fall, the disadvantage of the relatively expensive
fixed rate loan will be cancelled out by the less expensive
floating rate loan.

329. Disadvantages of smoothing
1)
2)
This hedging method reduces the comparative advantage a
company may gain by using fixed rate debt in preference to
floating rate debt and vice versa.

On top of this, the company may incur two lots of transaction
and arrangement costs.

330. Cont’d
•

Matching:
This hedging method involves the internal matching of
liabilities and assets which both have a common interest
rate.

331. 

If for instance, a decentralized group has two subsidiaries, one
subsidiary may be investing in the money markets at LIBOR,
while the other is borrowing through the same market at Libor.

If LIBOR rises, one subsidiary’s borrowing cost increases while
the other’s returns increase: the interest rates on the assets and
liabilities are matched.

332. Disadvantages of Matching
1)

One problem with this method is that it may be difficult for
commercial and industrial companies to match the magnitudes
and characteristics of their liabilities and assets as many
companies, while paying interest on their liabilities, do not receive
much income in the form of interest payments.

Matching is most widely used by financial institutions such as
banks, which derive large amounts of income from interest received
on advances.

333. INTERNAL MANAGEMENT OF EXCHANGE RATE RISK



There are a number of techniques that can be used to hedge
exchange rate risk internally. Generally, it is easier to hedge
transaction risk internally.

It is however difficult to hedge against economic risk as a result
of the difficulties associated with quantifying economic risk and
the long period over which economic risk exposure occurs.

334. TECHNIQUES DISCUSSED
•



Matching (Matching the inflows and outflows of
Foreign currency):
Netting only applies to transfers within a group of companies.
Matching can be used to hedge against transaction and
translation risk.

Matching can be used for both intra group transactions and
those involving third parties.

335. Companies that use this technique match the inflows and outflows
in different currencies caused by trade etc. so that it is only
necessary to deal on the forex markets for the unmatched portion of
the total transactions.

336. EXAMPLE:



In order to reduce translation risk, a company acquiring a foreign
asset could borrow funds denominated in the currency of the
country in which it is purchasing the asset, matching if possible
the term of the loan to the economic life of the asset.

As the exchange rate varies, the translated values of the asset
and liability increase and decrease in concert.

337. Cont’d
Also, to reduce transaction risk, a company,
selling goods in the U.S.A with prices
denominated in dollars could import raw
materials through a supplier that invoices in
dollars.

338. ..NETTING




Multinational companies often have subsidiaries in different
countries selling to other members of the group.

Netting is where the subsidiaries settle intra-organizational
currency debts for the net amount owed in a currency rather
than the gross amount.

Remember that Netting only applies to transfers within a
group of companies.

339. For example;
if a Ghanaian parent company owed a subsidiary in Nigeria,
and sold N2.2 million of goods to the subsidiary on credit,
while the Nigerian subsidiary is owed N1.5 million by the
Ghanaian company, instead of transferring a total of
N3.7million , the intra group transfer is the net amount of
N700,000.

340. 


This type of netting, involving two companies within a group, is
referred to as bilateral netting.

It is simple to operate without the intervention of a central
treasury.

Netting reduces the transaction costs of currency transfers in
terms of fees and commissions.

341. 

However, for organisations with a matrix of currency liabilities
between numerous subsidiaries, in different parts of the world,
multilateral netting is required.

Naturally, to net and match properly, the timing of the expected
receipts would have to be the same.

34
1

342. ..LEADING AND LAGGING:


Leading is the bringing forward from the original due dates the
payment of the debt.(e.g if you anticipate that the cedi will
depreciate….i.e from the viewpoint of an importer)

Lagging is the postponement of a payment beyond the due date.
(e.g if you think that the cedi will appreciate)

This speeding up or delaying of payments is particularly
useful if you are convinced that exchange rate will shift
significantly between now and the due date.

343. Example:
So using our earlier example, if the Ghanaian exporter which
has invoiced a Nigerian Company for N2.2 million on three
months’ credit and expects that the Nigerian Naira will ….

fall over the forth coming three months, it may try to obtain
payment immediately and then exchange for the Ghanaian Cedi at
the spot rate……

344. 

Naturally, the Nigerian firm will need an incentive to pay early
and this may be achieved by offering a discount for immediate
settlement.

An importer of goods in a currency which is anticipated to fall in
value may attempt to delay payment as long as possible.

345. ..INVOICING IN THE DOMESTIC CURRENCY:




One easy way to bypass exchange rate risk is to insist that all
foreign customers pay in your currency and your firm pays for all
imports in your home currency.

Employing this technique does not mean that the exchange
rate risk has gone away; it has just been passed on to the
customer.

This policy has an obvious drawback., …….

346. 

…. Your customers may dislike it, the marketability of your
products is reduced and your customers look elsewhere for
supplies.

If you are a monopoly supplier, you might get way with the
policy but for most firms this is a non starter.

347. ….DO NOTHING:




Under this policy, the Ghanaian firm invoices the Nigerian firm for
N2.2 million, waits three months and then exchanges into Ghana
Cedis at whatever spot rate is available then.

Perhaps an exchange rate gain will be made.

Many firms adopt this policy and take a ‘win some, lose some’
attitude.

348. 

Given the fees and other transaction costs of some hedging
strategies, this can make sense.

There are two considerations for managers here;

a) The first is their degree of risk aversion to higher cash flow
variability, coupled with the sensitivity of shareholders to
reported fluctuations of earnings due to foreign exchange
gains and losses.

349. 

b) The second which is related to the first point is the size of the
transaction.

If GHc1million is a large proportion of annual turnover and
greater than profit, then the managers may be more worried
about forex risk.

However, if GHc1million is a small fraction of turnover and
profit and the firm has numerous forex transactions, it may
choose to save on hedging costs.

350. MANAGING ECONOMIC
RISK(OPERATING EXPOSURE)




Economic exposure is concerned with the long term effects of
forex movements on the firm’s ability to compete, and add value.

These effects are very difficult to estimate in advance, given their
long term nature, and therefore the hedging techniques described
for transaction risk are of limited use.

The forward markets and matching may be used to a certain
extent….

351. 1)

The main method of insulating the firm from economic risk
is to position the company in such a way as to maintain
flexibility – to be able to react to changes in forex rates
which may be causing damage to the firm.

Firms which are internationally diversified may have a greater
degree of flexibility than those based in one or two markets.

352. 


For example, a company with production facilities in numerous
countries can shift output to those plants where exchange rate
has been favorable.

The international car assemblers have an advantage here over the
purely domestic producer.

Forex changes can impact on the costs of raw materials and other
inputs.

353. 

By maintaining flexibility in sourcing supplies, a firm could achieve
a competitive advantage by deliberately planning its affairs so that
it can switch supplies quickly and cheaply.

An aware multinational could allow for forex changes when
deciding in which country to launch an advertising campaign.

354. 

For e.g. it may be pointless increasing marketing spend in a
country whose currency has depreciated recently, making the
domestically produced competing product relatively cheap.

The principle of contingency planning to permit quick reaction to
forex changes applies to many areas of marketing and production
strategies.

355. RISK MANAGEMENT

External Management of Interest Rate and Exchange rate risk e.g.
forwards, futures, options (Derivatives).

356. EXTERNAL RISK MANAGEMENT



Over the past 30 years, the choice of external hedging methods
has increased dramatically.

Two of the longest standing and widely used external methods of
hedging interest rate and exchange rate risk are forward contracts
and money market hedges (borrowing and lending in the money
markets).

357. 


•
Companies can also choose from a wide range of derivative
instruments including future contracts, swaps and options.

HEDGING USING FORWARD CONTRACTS:
A forward contract is an agreement between two parties to undertake
an exchange at an agreed future date at a price agreed now.
There are two types of forward contracts.

Forward Rate Agreements (FRA’S) enable companies to fix, in
advance, either a future borrowing rate, or a future deposit rate,
based on a nominal principal amount, for a given period.

358. •

Forward Exchange Contracts (FEC’S)
enable companies to fix, in advance, future exchange rates on
an agreed quantity of foreign currency for delivery or purchase on
an agreed date.

359. FORWARD EXCHANGE CONTRACT EXAMPLE (COVERING USING
THE FORWARD MARKETS)
•
•
Suppose that on 15
th
November 2015 a UK exporter sells goods to a
customer in France invoiced at €5,000,000. Payment is due three
months later. With the spot rate of exchange at €1.3984/£, the
exporter in deciding to sell the goods has in mind a sales price of:
5,000,000 =£3,575,515
1.3984

The UK firm bases its decision on the profitability of the deal on this
amount expressed in pounds.

360. FEC Cont’d
•
•
•
However, the rate of exchange may vary between November and
February: the size and direction of the move is uncertain.

If sterling strengthens against the euro, the UK exporter makes a
currency loss by waiting three months and exchanging the euro
received into sterling at spot rates in February.

If, say, one pound is worth €1.6, the exporter will receive only £3,125,
000:
5,000,000 = £3,125,000
1.6
The loss due to currency movement is:

361. FEC Cont’d
•
•
£3,575,515
-£3,125,000
£450,515
If the sterling weakens to, say, €1.3/£, a currency gain is made. The
pounds received in February if euro’s are exchanged at the spot rate are:
5,000,000 =£3,846,154
1.3
The currency gain is:
£3,846,154
-£3,575,515
£270,639

362. FEC Cont’d
•
•
•
Rather than run the risk of a possible loss on the currency side of the
deal, the exporter may decide to cover in the forward market. Under this
arrangement, the exporter promises to sell €5,000,000 against sterling
in three months time (the agreement is made on 15
th
November for
delivery of currency in February).

If the forward rate available on 15
th
November is €1.3926/£, then this
forward contract means that the exporter will receive £3,590,406 in
February, regardless of the way in which spot exchange rates move over
the three months.

363. FEC Cont’d
•
•
5,000,000 =£3,590,406
1.3926
From the outset (in November), the exporter knew the amount
to be received in February. It might, with hindsight, have been
better not to use the forward market but to exchange the euro
at a spot rate of say €1.3/£.
This would have resulted in a larger income for the firm. But
there was uncertainty about the spot rate in February when the
export took place in November.

364. FEC Cont’d
•
•
If the spot rate in February had turned out to be
€1.6/£ the exporter would have made much less.

Covering in the forward market is a form of
insurance which leads to greater certainty – and
certainty has a value.

36
4

365. Forward contracts are generally set up via banking institutions and
are non-negotiable, legally binding contracts.

ADVANTAGES OF FORWARD CONTRACTS

1. They can be tailor – made with respect to maturity and size in
order to meet the requirements of the company.

366. 2. Although there is an initial arrangement fee, forward contracts do
not require the payment of margin, as with financial futures
contracts, nor do they require the payment of a premium, as with
traded options.

DISADVANTAGES OF FORWARD CONTRACTS

1. Forward contracts cannot be traded owing to their lack of
standardization.

367. 2. Also, the binding nature of a forward contract means that the
company must forgo any potential benefit from favorable
movements in exchange rates and interest rates.

3. Besides, to close the contract early may result in a penalty being
charged.
Despite these drawbacks, forward markets continue to flourish.

368.  
Forward Rate Agreement (FRA) example:

a)A company wants to borrow GHc5.6m in three months’ time for a
period of 6 months.

b) Interest rates are currently standing at 6% and the company
expects the rate to rise in 3 months time. The company therefore
decides to hedge using FRA.

c) The bank guarantees the company a rate of 6.5% on GHc5.6m for
6months starting in 3 months time. This is known as a 3 v 9 FRA.

369. d) If interest rates have increased after 3 months to, say, 7.5%,
the company will pay 7.5% interest on the GHc5.6 loan that it
takes out: this is 1% more than the agreed rate in the FRA.

e) The bank will make a compensating payment of £28,000
(1% × GHc5.6 ×6/12) to the company, covering the higher
cost of its borrowing.

370. 


f) If interest rates have decreased after 3months to say , 5%(1.5%
below the agreed rate), the company will have to make a £42000
payment to the bank.

This example is a gross simplification.

In reality FRA’s are agreed for three-month periods. So this
company could have two separate FRA’s for the year.

It would agree different rates for each three-month period with
two different banks, e.g, bank A and bank B.

371. HEDGING USING THE MONEY AND EURO
CURRENCY MARKETS.



Money market hedging involves borrowing in the money markets.

It involves setting up the opposite foreign currency transaction to
the one being hedged.

372. EXAMPLE – Money Market Hedge

a)A company expects to receive $180,000 in 3 months time
and wants to lock into the current exchange rate of $1.65/£.

b) It anticipates that the pound will appreciate against the dollar

c) To set up a money market hedge, the company sets up a
dollar debt by borrowing dollars now.

373. … It converts them into sterling at the current spot rate and
deposits the sterling proceeds on the sterling money market.

d) When the dollar loan matures, it is paid off by the expected
dollar receipt.

e) If the annual dollar borrowing rate is 7%, the three month
dollar borrowing rate is 1.75% i.e. 1+ (7% ×3/12).

374. f) If Z is the amount of dollars to be borrowed now, then:
Z×1.0175 = $180,000

So Z = $180,000 / 1.0175 = $176,904

g) The sterling value of these dollars at the current exchange rate is:
$176,904 = £107,215
1.65

375. h) If the annual sterling deposit rate is 6%, the 3 month sterling
deposit rate is 1.5% and the value in 3 months time will be:

£107,214 ×1.015 = £108,822
 
THE STEPS IN THE MONEY MARKET HEDGE ARE AS FOLLOWS:
1) Invoice customer for $180,000
2) Borrow $176904
3) Sell $176,904 at current spot rate to receive pounds now.

376. 4) In three months, receive $180,000 from customer.
5) Pay lender $180,000


END OF SLIDES