Buyers Credit and Suppliers Credit

Buyer’s Credit

Buyer’s Credits are a form of Eurocurrency loans designed to finance a specific transaction involving import of goods and services. Under this arrangement, lending bank(s) pay the exporter on presentation of shipping documents. The importer works out a deferred payment arrangement with the lending bank, which the bank treats as a loan. Large loans are club loans or syndicated loans. Many provisions in the loan agreement are quite similar to a general purpose syndicated credit. However, a number of formalities have to be completed before the exporter can draw funds. The interest rate of the loan is linked to a market index such as LIBOR. In some cases, a state Export Credit Agency from the exporter’s country may pay a subsidy to the banks so that an attractive funding cost can be offered to the importer.

Another aspect is the Line of Credit. Lines of Credit are like buyers credits but are much wider in scope. A typical buyer’s credit involves one transaction between one supplier and one buyer. A line of credit covers several purchase transactions with the buyer importing different items from different suppliers. Many buyers can also be involved provided the ultimate credit risk is that of a single buyer or guarantor.

Supplier’s Credit

In a supplier’s credit, the exporter extends credit to the importer by allowing it to pay on a deferred payment basis. Promissory notes issued by the importer evidence the credit. Like in forfeiting, the supplier can discount the paper with a bank.… Read the rest

International Payments Using Drafts

Commonly used in international trade, a draft is an unconditional order in writing – usually signed by the exporter (seller) and addressed to the importer (buyer) or the importer’s agent – ordering the importer to pay on demand, or at a fixed or determinable future date, the amount specified on its face. Such an instrument, also known as a bill of exchange, serves three important functions:

  1. To provide written evidence, in clear and simple terms, of financial obligation.
  2. To enable both parties to potentially reduce their costs of financing.
  3. To provide a negotiable and unconditional instrument (that is, payment must be made to any holder in due course despite any disputes over the underlying commercial transaction.)

Using a draft also enables an exporter to employ its bank as a collection agent. The bank forwards the draft or bill of exchange to the foreign buyer (either directly or through a branch or correspondent bank), collects on the drafts, and then remits the proceeds to the exporters. The bank has all the necessary documents for control of the merchandise and turns them over to the importer only when the draft has been paid or accepted in accordance with the exporter’s instructions. The conditions for a draft to be negotiable are that it must be:

  •  In writing
  •  Signed by the issuer (drawer)
  •  An unconditional order to pay
  •  A certain sum of money
  •  Payable on demand or at a definite future time
  •  Payable to order of bearer

There are usually three parties to draft.… Read the rest

Short-Term Financing of Multinational Corporations

Financing the working capital requirements of a multinational companies foreign affiliates poses a complex decision problem. This complexity stems from the large number of financing options available to the subsidiary of an MNC. Subsidiaries have access to funds from sister affiliates and the parent, as well as external sources. This article focuses on developing policies for borrowing from either within or without the companies when the risk of exchange rate changes is present and different tax rates and regulations are in effect.

There are four aspects of short-term overseas financing strategy namely;

  1. Identifying the key factors,
  2. Formulating and evaluating objectives,
  3. Describing available short-term borrowing options and
  4. Developing a methodology for calculating and comparing the effective after-tax dollar costs of these alternatives.
1. Identifying Key Factors

There are six key factors in short- term financing the MNCs they are deviations of interest rates, exchange risk, degree of risk aversion, borrowing strategy and currency risk, tax asymmetries and political risk.

  1. Deviations in the rate of interest are the first risk factor. If forward contracts are unavailable, the crucial issue is whether differences in nominal interest rates among currencies are matched by anticipated exchange rate changes. The key issue here is whether there are deviations from the international rate of interest. If deviations do exist, then expected dollar borrowing costs will vary by currency, leading to a decision problem. Trade—offs must then be made between the expected borrowing costs and the exchange risks associated with each financing option.
  2. The element of exchange risk is the second key factor.
Read the rest

Syndicated Euro Credits

History of Syndicated Euro Credits

Syndicated Euro Credits are in existence since the late 1960s. The first syndicate was organized by Bankers Trust in an effort to arrange a large credit for Austria. During the early seventies, Euromarkets saw the demand for Euro credits increasing from non-traditional and hitherto untested borrowers. The period after first oil crisis was marked by a boom phase. To cope with the increasing demand for funds, lenders expanded their business without undertaking due credit appraisal of their clients or the countries thus financed. Further, the European banks had short-term deposits while bulk of borrowers required long-term deposits. These landings were at fixed rates thus exposing these banks to interest rate risks. The banks evolved the concept of lending funds for medium longterm i.e. 7-15 years on a variable interest rate basis linked to the  Interbank Rate (LIBOR). Revision of rates would take place every 3-6 months. These loans are extended in currencies denominated by US Dollar, Yen and Euro.  Amortization of the loan would be by way of half-yearly installments on completion of 2-3 years of grace period. At present, this instrument on a variable interest rate basis has emerged as one of the most notable and popular financing instruments in the international financial markets. Syndicated Credit remains as the simplest way for different types of borrowers to raise forex finance.

Types of Syndicated Euro Credits

Syndicated Euro Credits are classified into two types – club loans and syndicated loans. The club loan is a private arrangement between lending bank and a borrower. … Read the rest

Types of Foreign Bonds

Yankee Bonds

Yankee Bonds are US dollar denominated issues by foreign borrowers (usually foreign governments or entities, supranationals and highly rated corporate borrowers) in the US bond markets. Yankee bond has certain peculiar features associated with the US domestic market. SEC regulates the international bond issues and requires complete disclosure documents in detail than the prospectus used in Eurobond issues. Foreign borrower will have to adopt the US accounting practices and the US credit rating agencies will have to provide rating for these bonds. These bonds are sponsored by a US domestic underwriting syndicate and require SEBI (Securities and Exchange Board of India) registration prior to selling them in the domestic US market. Reliance Industries Ltd. has been the most successful corporate to tap this instrument with a 50-year, $50 million Yankee Bond issue.

Samurai Bonds

These are bonds issued by non-Japanese borrowers in the domestic Japanese markets. Borrowers are supranationals and have at least a minimum investment grade rating (A rated). The maturities range between 3-20 years. The priority for allowing issuance of Samurai bonds is given to the sovereigns after the supranationals and their entities and to high quality private corporations specifically if there are Japanese trade links. This is also a registered bond and the settlement and administrative procedures make it relatively costly. Among the Yen financing instruments, this instrument is the most expensive in terms of issuing costs. As this instrument is issued for the public, the arrangements for underwriting and selling have to be made which involves large documentation. … Read the rest

Euro Notes and Euro Commercial Paper

Euro Notes

Euro Notes are like promissory notes issued by companies for obtaining short term funds. They emerged in early 1980s with growing securitization in the international financial market. They are denominated in any currency other than the currency of the country where they are issued. They represent low cost funding route. Documentation facilities are the minimum. They can be easily tailored to suit the requirements of different kinds of borrowers. Investors too prefer them in view of short maturity.

When the issuer plans to issue Euro notes, it hires the services of facility agents or the lead arranger. On the advice of the lead arranger, it issues the notes, gets them underwritten and sells them through the placement agents. After the selling period is over the underwriter buys the unsold issues.

The Euro notes carry three main cost components: Underwriting fee; One time management fee for structuring, pricing and documentation; and Margin on the notes themselves. The margin is either in the form of spread above/below LIBOR or built into the note price itself.

The documentation is standardized. The documents accompanying notes are usually underwriting agreement, paying agency agreement, and information memorandum showing, among other things, the financial position of the issuer. The notes are settled either through physical delivery or through clearing.

In course of time, a few variants of Euro notes issue system have evolved. The first is the revolving underwriting facility in which there is a sole placement agent who allocates the notes among investors at a uniform preset yield.… Read the rest