Letter of credit short term markatable securities

Working capital Financing

1. Letter Of Credit

2. Definition A document issued by a financial institution on behalf of a buyer stating the amount of credit the buyer has available, and that the institution will honor drafts up to that amount written by the buyer. It gives the buyer the prestige and financial backing of the issuing institution and satisfies the requirements of the seller in completing the transaction. The accepting institution has a prior agreement as to how the buyer will pay for the drafts as they are presented. A commitment, usually by a bank on behalf of a client, to pay a beneficiary a stated amount of money under specified conditions.

3. Parties involved in LC transaction The Applicant is the party that arranges for the letter of credit to be issued. The Beneficiary is the party named in the letter of credit in whose favor the letter of credit is issued. The Issuing or Opening Bank is the applicant’s bank that issues or opens the letter of credit in favor of the beneficiary and substitutes its creditworthiness for that of the applicant.

4. Parties involved in LC transaction (Contd..) An Advising Bank may be named in the letter of credit to advise the beneficiary that the letter of credit was issued. The role of the Advising Bank is limited to establish apparent authenticity of the credit, which it advises. The Paying Bank is the bank nominated in the letter of credit that makes payment to the beneficiary, after determining that documents conform, and upon receipt of funds from the issuing bank or another intermediary bank nominated by the issuing bank. The Confirming Bank is the bank, which, under instruction from the issuing bank, substitutes its creditworthiness for that of the issuing bank. It ultimately assumes the issuing bank’s commitment to pay.

5. Letter of Credit Process

6. Commercial Letter of Credit Flow Applicant approaches Issuing/ Opening Bank with LC application form duly filled and requests Issuing Bank to issue a Letter of Credit in favor of Beneficiary. Issuing Bank issues a Letter of Credit as per the application submitted by an Applicant and sends it to the Advising Bank, which is located in Beneficiary’s country, to formally advise the LC to the beneficiary. Advising Bank advises the LC to the Beneficiary. Once Beneficiary receives the LC and if it suits his/ her requirements, he/ she prepares the goods and hands over them to the carrier for dispatching to the Applicant. He/ She then hands over the documents along with the Transport Document as per LC to the Negotiating Bank to be forwarded to the Issuing Bank.

7. Commercial Letter of Credit Flow (Contd ..) Issuing Bank reimburses the Negotiating Bank with the amount of the LC post Negotiating Bank’s confirmation that they have negotiated the documents in strict conformity of the LC terms. Negotiating Bank makes the payment to the Beneficiary. Simultaneously, the Negotiating Bank forwards the documents to the Issuing Bank to be released to the Applicant to claim the goods from the carrier. Applicant reimburses the Issuing Bank for the amount, which it had paid to the Negotiating Bank. Issuing Bank releases all documents along with the titled Transport Documents to the Applicant.

8. Types of Letters of Credit

9. Irrevocable LC. This LC cannot be cancelled or modified without consent of the beneficiary (Seller). This LC reflects absolute liability of the Bank (issuer) to the other party. Revocable LC . This LC type can be cancelled or modified by the Bank (issuer) at the customer's instructions without prior agreement of the beneficiary (Seller). The Bank will not have any liabilities to the beneficiary after revocation of the LC. Stand-by LC. This LC is closer to the bank guarantee and gives more flexible collaboration opportunity to Seller and Buyer. The Bank will honor the LC when the Buyer fails to fulfill payment liabilities to Seller.

10. Confirmed LC. In addition to the Bank guarantee of the LC issuer, this LC type is confirmed by the Seller's bank or any other bank. Irrespective to the payment by the Bank issuing the LC (issuer), the Bank confirming the LC is liable for performance of obligations. Unconfirmed LC. Only the Bank issuing the LC will be liable for payment of this LC. Transferable LC. This LC enables the Seller to assign part of the letter of credit to other party(ies). This LC is especially beneficial in those cases when the Seller is not a sole manufacturer of the goods and purchases some parts from other parties, as it eliminates the necessity of opening several LC's for other parties. Back-to-Back LC. This LC type considers issuing the second LC on the basis of the first letter of credit. LC is opened in favor of intermediary as per the Buyer's instructions and on the basis of this LC and instructions of the intermediary a new LC is opened in favor of Seller of the goods.

11. Payment at Sight LC . According to this LC, payment is made to the seller immediately (maximum within 7 days) after the required documents have been submitted. Deferred Payment LC . According to this LC the payment to the seller is not made when the documents are submitted, but instead at a later period defined in the letter of credit. In most cases the payment in favor of Seller under this LC is made upon receipt of goods by the Buyer. Red Clause LC. The seller can request an advance for an agreed amount of the LC before shipment of goods and submittal of required documents. This red clause is so termed because it is usually printed in red on the document to draw attention to "advance payment" term of the credit. Green clause letter of credit . This is a normal documentary letter of credit , which provides a secured form of credit in that exporters can draw an agreed percentage of the value of the goods to be shipped against presentation of warehouse receipts as collateral.

12. Settlements Under a Letter of Credit All commercial letters of credit must clearly indicate whether they are payable by sight payment, by deferred payment, by acceptance, or by negotiation. These are noted as formal demands under the terms of the commercial letter of credit.

13. Settlements Under a Letter of Credit (Contd..) In a sight payment , the commercial letter of credit is payable when the beneficiary presents the complying documents and if the presentation takes place on or before the expiration of the commercial letter of credit. In a deferred payment , the commercial letter of credit is payable on a specified future date. The beneficiary may present the complying documents at an earlier date, but the commercial letter of credit is payable only on the specified future date.

14. Settlements Under a Letter of Credit (Contd..) An acceptance is a time draft drawn on, and accepted by, a banking institution, which promises to honor the draft at a specified future date. The act of acceptance is without recourse as it is a commitment to pay the face amount of the accepted draft. Under negotiation, the negotiating bank , a third party negotiator, expedites payment to the beneficiary upon the beneficiary’s presentation of the complying documents to the negotiating bank. The bank pays the beneficiary, normally at a discount of the face amount of the value of the documents, and then presents the complying documents, including a sight or time draft, to the issuing bank to receive full payment at sight or at a specified future date.

15. Advantages of Letter of Credit (Exporter) Credit risk eliminated Reduces exchange rate and political risk No Need for Credit Check Requirements to pay are well-known Pre shipment risk avoided Facilitates financing Immediate payment

16. Advantages of Letter of Credit (Importer) Expert Examination of Documents Sources of Supply expand Financing No cash tied up Payment only after compliance To ship by a certain date requires an on-board bill of lading No risk in import

17. Risks involved Since all the parties involved in Letter of Credit deal with the documents and not with the goods, the risk of Beneficiary not shipping goods as mentioned in the LC is still persists. The Letter of Credit as a payment method is costlier than other methods of payment such as Open Account or Collection The Beneficiary’s documents must comply with the terms and conditions of the Letter of Credit for Issuing Bank to make the payment. The Beneficiary is exposed to the Commercial risk on Issuing Bank, Political risk on the Issuing Bank’s country and Foreign Exchange Risk in case of Usance Letter of Credits.