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ACF 465

INTERNATIONAL TRADE FINANCE


Lecture Notes

Mr. Kwasi Poku


kwapok25@gmail.com // 0207401585
Jan 2016

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.
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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.

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.
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.
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Course Objectives

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 non-traditional facilities provided by banks to facilitate export trade.
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

Course Outline
Unit 1: OVERVIEW OF INTERNATIONAL TRADE FINANCE
Unit 2: STRATEGIC OPTIONS FOR ENTERING AND
COMPETING IN FOREIGN MARKETS; MODE OF ENTRY INTO
EXPORT MARKETS
Unit 3: METHODS OF PAYMENT IN INTERNATIONAL TRADE
Unit 4: INCOTERMS/TERMS OF DELIVERY/SHIPPING TERMS
Unit 3: DOCUMENTS USED IN INTERNATIONAL TRADE
Unit 6: DOCUMENTARY CREDIT
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Course Outline
Unit 7: OVERVIEW OF EXPORT FINANCE
Unit 8: IMPORT FINANCING
Unit 9: METHODS OF INTERNATIONAL SETTLEMENT
THROUGH BANKS
Unit 10: TRAVEL FACILITIES AND NON FINANCIAL SERVICES
Unit 11: FOREIGN EXCHANGE MARKETS

Grading
Continuous assessment: 30%
End of semester examination: 70%

Recommended Reading
Arnold, G. (2008). Corporate Financial Management. 4th Edition. Financial Times/Pearson
Education Ltd
Atuahene, R. (2016). Finance of International Trade-Chartered Institute of Bankers (GH),
2nd Edition.
Cowdell, P. and Hyde, D (2003). International Trade Finance-The Institute of Financial
Services (UK), 8th Edition.
Cranston, R. (2007). Principles of Banking Law. 2nd Edition. Oxford University Press, UK.
Luke, K.W. (2015). International Trade Finance: A Practical Guide. 2nd Edition. City
University of Hong Kong Press.
Watson, D. and Head, A. (2010). Corporate Finance: Principles and Practice. 5th Edition.
Financial Times/Prentice Hall.
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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
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

Introduction
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.

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:

Why Companies Expand Into Foreign


Markets
To Gain Access To New Customers

Expanding into foreign markets offers potential for increased


revenues, profits, and long-term growth and becomes an especially
attractive option when a companys 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.

Why Companies Expand Into Foreign Markets


To Achieve

Lower Costs And Enhance The Firms 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 firms
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.

Why Companies Expand Into Foreign


Markets
Also, some companies abroad may have a competitive advantage in
the provision of certain goods and services.
o The need to earn more profit by selling goods or services in overseas
markets.
o 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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Why Companies Expand Into Foreign Markets


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

Differences Between International Trade and Domestic Trade

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

Inherent Problems / Difficulties In International Trade


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, non-payment on the part of the
buyer, changes in customers taste, substitute product and non-delivery
time lag. Differences in time zone also results in communication
difficulties.

Inherent Problems / Difficulties In International Trade


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.

Inherent Problems / Difficulties In International Trade


Differences in laws/customs
Lack of knowledge and understanding about customs, habits and laws of the
buyers or the sellers country create an extra degree of uncertainty or mistrust
between the two parties involved in trade. e.g. exporting pork to a Moslem
country.
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 makes international trade more complicated
than in domestic trade.

Inherent Problems / Difficulties In International Trade


Government regulations
Government rules and restrictions can be a serious threat to international trade.
Such regulations and restrictions include:
o Exchange control regulations
o Export licensing
o Import licensing
o Trade Embargoes
o Import quotas
o Health and hygiene requirements, notably on food
o Patent and trademarks

Inherent Problems / Difficulties In International Trade


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
I. Regulations requiring individuals or firms to obtain foreign exchange approval from
the Central Bank before engaging international trade activities.
II.Regulations rationing the supply of foreign exchange to those wishing to make
payment abroad in a foreign currency.
III.Regulations making the holding of foreign currency or exchange illegal by
legislation.
.
Transit charges

Theories of International Trade


In the 1600s and 1700s, mercantilism stressed that countries should
simultaneously encourage exports and discourage imports. Mercantilism is
an old theory, but it echoes in modern politics and trade policies of
countries.
Adam Smith, who developed the theory of absolute advantage, was the first
to explain why unrestricted free trade is beneficial to a country. He argued
that the invisible of the market mechanism should be the determinant of a
countrys import and exports.
Two theories have been developed from Adam Smiths absolute advantage
theory.

Theories in International Trade Contd

The Comparative Advantage Theory by David Ricardo


The Heckscher-Ohlin Theory by Eli Heckscher and Bertil
Ohlin
The Heckscher-Ohlin theory is preferred on theoretical
grounds, but in real-world international trade patterns it turned
out not to be easily transferred to as the Leontief Paradox.
Another theory that tried to explain the failure of the
Heckscher-Ohlin theory was the product life cycle theory
developed by Raymond Vernon.

Mercantilism
According to Wild, (2000), the trade theory that states nations
should accumulate financial wealth usually in the form of gold
by encouraging exports and discouraging imports is called
mercantilism. According to this theory other measures of
countries well-being, such as living standards or human
development are irrelevant.
Mainly Great Britain, France, The Netherlands, Portugal and
Spain used mercantilism during the 1500s to the late 1700s.
Mercantilism countries practiced the so-called zero-sum game.

Theory of Absolute Advantage


Adam Smith (1776) claimed that market forces should determine
the direction, volume and composition of international trade. He
argued that under force, unregulated trade, each nation should
specialize in producing those goods and services it could produce
most efficiently. Some of these goods and services would be
exported to pay for other imported goods and services that could
be produced more efficiently elsewhere.
The capability of one nation to produce more of a good/service
with the same amount of input than another country represented
its absolute advantage.

Comparative Advantage
The principle of comparative advantage states that a country
should specialize in producing and exporting those products
and services in which it has a comparative or relative cost,
advantage compared with other countries and should import
those goods in which it has a comparative disadvantage.
Assumptions that countries are driven only by the
maximization of production and consumption and not by
issues driven out of concern for workers or consumers limit
the real-world application of this theory.

Heckscher-Ohlin Theory
The Heckscher-Ohlin theory stresses that countries should produce
and export goods that requires resources that are abundant and import
goods that are short in supply. The theory states that a country should
specialize in production and export using factors that are most
abundant and thus the cheapest to produce, as opposed to earlier
theories that emphasized the goods it could produce most efficiently.

The Product Life Cycle Theory


The international product life cycle stresses that a
company will begin to export its product and later take
on foreign direct investments as the product moves
through its life cycle. Eventually a countrys export
becomes its import.
Although the theory is developed around the U.S, it
can be generalized and applied to any of the developed
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First Mover Theory

The first mover theory states that firms that enter the export market first
will be able to gain large market share, permitting them to enter obtain
benefits of reduced costs and improved technical expertise early. This can
discourage new entrants that might have to enter at a higher cost.
Sources of advantages of first include:
Technological leadership due to a quick fall off on costs, the learning or
experience curve (Liberation 1987) or success in research and
development (Mansfield, 1986)
Preemption of physical or spiral assets such as skilled labour, unique
channels distribution or manufacturing facilities
Buyer switching costs

The Linder Theory Of Overlapping Demand


Theory of overlapping demand states that because customers tastes
are strongly affected by income level, a nations income per capita
level determines the type of commodities they will demand and as
such, the kinds of commodities produced to meet this demand reflect
the countrys per capita level. International trade will be greater
between nations with similar levels of per capita income.
The Linder theory deduces that international trade in manufactured
goods will be greater between those with dissimilar levels of per capita
income.

Porters Competitive Advantage Of Nations


The Porter Theory claims that four kinds of variables will have an
impact on the ability of the local firms in a country to utilize the
countrys resources to gain a competitive advantage:
Demand conditions nature of the domestic demand
If a firms customers are demanding, it will strive to produce highquality and innovative products, and in doing so will obtain a global
comparative advantage over companies located where domestic
pressure is less.

Porters Competitive Advantage Of Nations


Factor conditions level and composition of factors of production
Porter distinguishes between the basic factors (Heckscher-Ohlin
theory) and the advanced factors (a nations infrastructure). Lack of
natural endowments has caused nations to invest in the creation of the
advanced factors, such as education of its workforce, free ports and
advanced communications systems to enable their industries to be
competitive globally.

Porters Competitive Advantage Of Nations


Related and supporting industries suppliers and industry support services.
For decades, firms in an industry with their suppliers and so forth, have tended
to form a group in given location, often without no apparent reason.
Firm strategy, structure and rivalry the extent of domestic competition the
existence of barriers to entry and the firms management style and organization.
Porter points outs that companies subject to heavy competition in their domestic
markets are constantly working to improve their efficiency, which makes them
more competitive internationally. For decades, firms in oligopolistic industries
have carefully watched their competitors every move and have entered into
foreign markets because their competitors had gone there.

Other Theories of International Trade


Krugman Theory

The theory states that the economies of scale and imperfect


competition explain high levels of intra-industry trade. Also
economies of scale and the experience arrived can permit a
nations industries to become low cost producers without
requiring that the nation have abundance of a certain class of
production factors.

Other Theories of International Trade


The New Trade Theory
The new trade theory notes that the bigger the firm or industry, the
more the efficiency of its operations in that cost per unit falls as a firm
or industry increases output. The increase in output must however be
met with an increase in the market size if it is to be sustainable. The
new trade theorists explain that because engaging in international trade
market size, this decreases the average cost in an industry described by
monopolistic competition.

Summary Of International Trade Theory


International trade occurs primarily because of relative price differences among
nations. These differences stem from differences in production costs, which results
from:
Differences in the endowments of the factors of production.
Differences in the levels of technology that determine the factor intensities used.
Differences in the efficiencies with which these factor intensities are utilized.
Foreign exchange rates.
However, taste differences, a demand variable can reverse the direction of trade
predicted by the theory clearly shows that nations will attain a higher level of living by
specializing in goods for which they possess a comparative advantage. Generally, trade
restrictions that stop this free flow of goods will harm a nations welfare.

Principal Players In International Trade


I. 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.

Other Players In The International Trade Market


II. 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.
III. Freight Forwarders
Freight forwarders, 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.

Other Players In The International Trade Market


IV. 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.
V. 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.

Other Players In The International Trade Market


VI. 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.

Other Players In The International Trade


Market
VII. 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 world-wide 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.
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Other Players In The International Trade Market


VIII. 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.

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 involved short landing or non delivery of goods and
delivery of sub-standard goods.

Other Risks Involved In Cross Trading


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:
a) 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.
b) Bankruptcy/Insolvency or Liquidation
c) Undeveloped mechanisms for efficient assessment of borrowers by credit
referencing agencies in the country.

Other Risks Involved In Cross Trading


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.
Sovereign Risk

This arises when a sovereign government of a country:


a) Obtains a loan from a foreign lender
b) Incurs a debt to a foreign supplier
c) Guarantees a loan or debt on behalf of a third party.

Other Risks Involved In Cross Trading


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.
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

Other Risks Involved In Cross Trading


Bank Risk
This arises due to the liquidation or insolvency of a bank that is supposed to
honour payments.
International Fraud
Examples include forged documentary credits, over/under insurance, cargo
theft etc.

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

International Fraud and Trade Based Money Laundering

The complexity associated with foreign exchange transactions an


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
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International Fraud and Trade Based Money Laundering


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.

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

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 over-invoice imports or under-invoice
exports.

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.

Basic Trade-Based Money Laundering Typologies (AML Act 749, Act 2008 &
CFT Act 762, Act 2008 Bank of Ghana/FIC Guidelines on Money Laundering
Regulation 2011)

Trade-based laundering is defined as the process of


disguising the proceeds of crime and moving value through
the use of trade transactions in an attempt to legitimize their
illicit origin. This can be achieved through the
misrepresentation of the price, quantity or quality of imports
or exports.

The basic techniques of trade-based money laundering include:


Over-and under-invoicing of goods and services
The key element of this techniques is the misrepresentation of the price of the
good and service in order to price of the good or service in order to transfer
additional value between the importer and exporter
Multiple invoicing of goods and services
By invoicing the same good or service more than once, a money launderer or
terrorist financier is able to justify multiple payments for the same shipment of
goods and services.
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Basic Trade-Based Money Laundering Typologies (AML Act 749, Act 2008
& CFT Act 762, Act 2008 Bank of Ghana/FIC Guidelines on Money
Laundering Regulation 2011)

Over-and under-shipments of goods and services


A money launderer can overstate or understate the quantity of goods
being shipped or services being provided. In extreme, an exporter may not
ship any goods at all, but simply collude with an importer to ensure that
all shipping and customs documents associated with this so-called
phantom shipment are routinely processed.
Falsely described goods and services
A money launderer can also misrepresent the quality or type of a good or
service. This creates a discrepancy between what appears on the shipping
and customs documents and what is actually shipped.

International Trade Frauds


International trade fraud are basically paper based and
electronically based frauds and these are happening as results
of information technology and sophisticated desktop
technology. Letters of credit in international trade can be used
to further fraudulent trading patterns with, for example,
partners trying to unlawfully to obtain payment for defective
or non-existent goods.

Fraud Typologies
There are different and numerous types of trade fraud that can be enumerated
including:
Documentary Fraud
Documentary fraud in commodity trading occurs primarily for commodities that are in
high demand. Documentary fraud relates to many scenarios such as forging, alteration
or general misuse of the letter of credit and/or the documents that accompany the
letter of credit (i.e. bill of lading, commercial invoice, insurance certificate, certificate
of origin, inspection certificate, etc.). In some cases, the documents may be forged or
falsified after their execution, in others they may be authentic documents but with false
information.

Fraud Typologies
The bill of lading is the most important document likely to be used in
documentary fraud, due its multipurpose appellation. A predated bill of
exchange is issued principally for two reasons:
i.

To avoid paying indemnity

ii. To make a profit in the shipping price

Fraud Typologies
Deviation, Piracy and Theft
These types of frauds occur principally with high-value cargo, in port
areas that are not under close supervision and control, during times of
depressed freight markets, when a charter party is not being paid for his
work, or when additional costs occur through excessive and unforeseen
congestion in a port. An example of deviation fraud is the phantom ship
frauds which are aimed at the theft of ship-loads of cargo.

Fraud Typologies
Marine Insurance Fraud
Marine insurance fraud implies a fraudulent misrepresentation or nondisclosure of a material fact to the insurer concerning not only the value
of the cargo, but also the existence and ownership of the cargo. Such
fraud is limited to countries with foreign exchange control and
restrictions, which use over-valued invoices in order to exchange local
currencies into hard currencies.

The Role of Banks In International Trade


Provision of Banking facilities
I. Maintaining customers foreign & local accounts
II. Provision of short/medium term credit facilities
III. Providing documentary credit & documentary collection services
IV. Negotiating Bankers Acceptances, Discounting & Factoring services
V. Arranging finance for exporters under various Bank of Ghana
finance schemes (private enterprise scheme, EDIF, etc.)

The Role of Banks In International Trade

I.

Collection & Transfer of funds & Settlement


Transmitting payments in foreign currency on behalf of importers/lenders

II. International money transfers


. Provision of foreign exchange services
I.

Provide foreign exchange in spot/forward market

II. Provide travel facilities, foreign currency, foreign draft, traveller's cheques

The Role of Banks In International Trade


Facilitation of International Trade by providing information and data
I.

Status report on foreign buyers, suppliers & banks (Banks rating) through correspondence banks

II. General information on the Economic and Political situation in trading countries such as:
a. Inflation
b. Foreign exchange position (supply & demand)
c. Exchange controls
d. Money supply
e. Balance of payment
f. Import/Export regulations
g. Interest rates

The Role of Banks In International Trade


I.

Assisting in finding markets for goods and services

II. Advising on various ICCO publications on INCOTERMS, Documentary


credits/Documentary collection and others

. Provision of Specialized Trade Finance


I.

Standby Credit Arrangement

II. Red Clause Credit and Green Clause Credit


III. Bankers Acceptances
IV. Forfaiting
V. Leasing/Hire Purchase

Unit 2: Strategic Options For Entering


And Competing In Foreign Markets;
Mode of Entry Into Export Markets
Objectives
To describe the major strategic options available to exporters in the
foreign market
To explain export strategy
To discuss the strategic options in export trade
To explain the types of strategic options in the foreign market
To explain the types of global marketing strategies

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets

Introduction
For a company to enter into a foreign market, the company must decide the
best way to market the product or service. There are several ways of doing
this , but the company must decide which method will most appropriately suit
the firms needs. These different methods are export strategies: Contractual
Joint Venture, Equity Joint Venture or through wholly owned subsidiaries.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets

Exporting As An Entry Strategy


Export Strategy
Exporting is a method that companies can use to ship products to foreign
countries to market the goods. There are several advantages to using the
export strategy, including there being little initial cost and no upfront
capital investment and it being the least risky method of entering into a
foreign market once the method of settlement is agreed upon.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets
Indirect Exporting
Indirect exporting includes dealing through export management companies of
foreign agents, merchants or distributors. Several types of intermediaries located
in the domestic market are ready to assist a manufacturer in contacting
international markets or buyers.
Direct Exporting
Direct exporting includes setting up an export department within the firm or
having the firms sales force sell directly to foreign customers or marketing
intermediaries. A company engages in direct exporting when it exports through
intermediaries located in foreign markets. Although a direct exporting operation
requires a larger degree of expertise, this method of entry does provide the
company with a greater degree of control over its distribution channels than would

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets
Foreign Production As An Entry Strategy
Many companies realize that to open a new market and serve local customers
better, exporting into that market is not a sufficiently strong commitment to realize
strong local presence. As a result, these companies look for ways to strengthen
their base by entering into one of several ways to manufacture the product in the
target country.
Licensing
Licensing is similar to contract manufacturing, as the foreign licensee receives
specifications for producing products locally, but the licensor generally receives a
set fee or royalty rather than finished products. Licensing may offer the foreign
firm access to brands, trademarks, trade secrets or patents associated with the
products manufactured.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets
Franchising
Franchising is a special form of licensing in which the franchiser makes total marketing
program available including the brand name, logo, products and method of operation.
Usually, the franchise agreement is more comprehensive than a regular licensing
agreement in as much as the total operation of the franchisee is described. It differs from
licensing principally in the depth and scope of quality controls placed on all phases of
the franchisees operation.
Local Manufacturing
Many companies find it to their advantage to manufacture locally instead of supplying
the particular market with products made elsewhere. Numerous factors such as local
costs, market size, tariffs, laws and political considerations may affect a choice to
produce locally. The type of local production depends on the arrangements made; it may
be contract manufacturing, assembly or fully integrated production.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets
Ownership Strategies
Companies entering foreign markets have to decide on more than the most
suitable entry strategy. They also need to arrange ownership, either as a
wholly owned subsidiary, in a joint venture, or more recently in strategic
alliance with local investors.
Contractual Joint Venture Strategy
By definition, contractual joint ventures are not joint ventures, but similar to
licensing agreements. Licensing essentially permits a company in the target
country to use the property of the licensor, where the licensee pays a fee in
exchange for the rights to use the intangible property and possibly for
technical assistance.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets

Equity Joint Venture Strategy


With contractual joint venture, the domestic company usually derives their
compensation from a one-time upfront fee plus some percentage of royalty
from the foreign company for an agreed period of time. In contrast, a joint
venture involves a domestic company that usually teams up with a
company in the target country, resulting in a limited liability company
being formed by two entities.
There are five common objectives that companies seek in a joint venture:
market entry, risk/reward sharing, technology sharing, joint product
development, and conforming to government regulations.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets
Wholly Owned Subsidiary Strategy
This term is often interchangeable with foreign direct investment, where the company has
direct ownership of facilities in the foreign country. Using a wholly owned operation to
enter a foreign market usually involves a high level of risk and cost, but the potential
profits may also be high. This strategy transfers capital, staff and/or technology into a
foreign market so that a product may be developed, manufactured, marketed, sold, and/or
serviced from a wholly owned foreign location.
Strategic Alliances
Alliances are different from traditional joint ventures. In an alliance, two firms pool their
resources directly in a collaboration that goes beyond the limits of a joint venture.
Although a new entity may be formed, it is not a requirement. In an alliance, each partner
brings a particular skill or resource which is usually complementary- and by joining forces,
each expects to profit from the others experience, and thus producing positive synergies.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets
Entering Markets Through Mergers And Acquisitions
The need to enter markets very quickly than through building a base from
scratch or entering some type of collaboration has made the acquisition route
extremely attractive. This trend has been aided by the opening of many financial
markets, making the acquisition of publicly traded companies much easier.
Global Marketing Strategy
In the international arena, companies face a strategic dilemma between global
integration and national responsiveness. Companies must decide whether they
want each global affiliate to act autonomously or whether activities should be
standardized and centralized across countries.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets
There are three main global strategies:
Globalization strategy
When a company chooses a strategy of globalization, it means that its product design and
advertising strategies are standardized throughout the world. This approach is based on the
assumption that a single global market exist for consumer and industrial product. The theory
is that people everywhere want to buy the same product and live the same way.
Multi domestic
When a company chooses a multi domestic strategy, it means that competition in each
country is handled independently of industry competition in other countries. Multi domestic
strategy is about modification of product design and advertising strategies to suit the specific
needs of individual countries. Many companies reject the idea of a single global market on
the view of cultural and taste differences.

Strategic Options For Entering And Competing In Foreign


Markets; Mode of Entry Into Export Markets

Transnational strategy

A transnational strategy seeks to achieve both global integration and national


responsiveness. A transnational strategy combines global coordination to attain
efficiency with flexibility to meet specific needs in various countries. A true
transnational strategy is difficult to achieve because one goal requires close
global coordination while the other requires local flexibility.
Although most multinational companies want to achieve some degree of global
integration to hold cost down, even global products may require some
customization to meet government regulations in various countries or some
tailoring to fit consumer preferences.

Unit 3: Methods Of Payment In International Trade


Objectives

To explain the different modes 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

Introduction
When a 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.

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

Payment Consideration
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

Means of Payment

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 sellers bank to issue advance payment bond in respect of monies
advanced, to protect himself from associated risks. This method of payment is used
when:
I.

The buyers credit is doubtful; or when the parties are doing business for the first
time.

II. There is an unstable political or economic environment in the buyers country


III. There is a potential delay in the receipt of funds from the buyer, perhaps due to
risks beyond his control

Means of Payment
Advantages to the seller

I.

Immediate use of funds

Disadvantages to the buyer

II. Tying up his capital prior to receipt of the goods/services


III. Has no assurance that goods/services will be:
a. supplied
b. received
c. received timely
d. received in the quality or quantity ordered

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.

Open Account
Advantages to the buyer:
I.

Payment is effected after receipt of goods/services

II.

Payment is conditioned on the political, legal and economic issues as


previously discussed

Disadvantages to the seller


III. The title of goods is released without payment assurance
IV. The possibility of political events deferring or blocking movement of
funds to him
V. Tied up capital until services are accepted and payment is made

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 sellers bank with bank with clear instructions for
collection through one of his 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
exporters bank send to the importers bank.

Normal Precautions To Be Taken By The Seller


The seller should:
I.

obtain a credit report or status opinion on the buyer,

II. obtain an economic and political analysis of the country of import


concerning political stability, foreign currency position and foreign
exchange regulations.
III. not consign the goods to the buyer, nor consign the goods to the
buyers bank without that banks prior agreement.
IV. establish alternative procedures for the resale, reshipment or
warehousing of the goods in the event of non-payment by the buyer.

Documentary Collection
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 exporters 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.

Documentary Collection
Advantages to the Seller
I.

documentary collections are uncomplicated and inexpensive

II. documents of value are not released to the buyer until payment or acceptance has
been effected
III. collections may facilitate pre-export or post-export financing
Disadvantages to the Seller
IV. ships the goods without an unconditional promise of payment by the buyer
V. there is no guarantee of payment or immediate payment by the buyer
VI. ties up his capital until the funds are received

Documentary Collection
Advantage to the Buyer
I.

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


II. by defaulting on bill of exchange, he may become legally liable
III. trades reputation may be damaged if the collection remains unpaid

Clean Collection
An arrangement where the seller draws only a bill of exchange on the
buyer for the value of the goods or services and presents the bill of
exchange to his bank. The sellers bank sends the bill of exchange
along with a collection instruction letter to a corresponding bank,
usually in the same city as the buyers.
A clean collection may represent:
an underlying merchandise transaction, or
an underlying financial transaction

Direct Collection
An arrangement where the seller obtains his banks pre-numbered
direct collection letter, thus enabling him to send his documents
directly to his banks correspondent bank for collection. This kind of
collection accelerates the paper-work 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.

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 sellers desire
for cash and the importers 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.

Goods on Consignment
Where an exporter is satisfied with the standing of an importer, or
appoints an agent after careful enquiries, arrangements might be made
to forward goods on consignment. Payment will only be made when
the goods have been sold. Depending upon the standing of the agent,
the goods might be forwarded to him. Another method is for the
exporters bank to dispatch the shipping documents to one of their
correspondents and arrange warehousing and insurance facilities.

Risks for Exporter And Importer On Consignment Sales


Risks for the exporter
The exporter should ensure that there are no local restrictions that prohibit or
interfere with the import of goods on this basis- or the remittance of the sale
proceeds to the exporter. If the goods remain unsold, there may be difficulty
in exporting them back to the exporter.
Risks for the importer
There are no risks for an importer and he only pays when he sold the goodstaking percentage from the proceeds. It should be noted that all the
aforementioned are methods of obtaining payment for goods shipped and not
methods of obtaining finance.

Problems Concerning Payments in Advance and Open


Account Trading

Payment In Advance
When receiving payment in advance, the customer
may have simply sent a pro forma or invoice to his
purchaser overseas. Almost invariably, the customer
may have to arrange for an advance payment
guarantee. This could be for a proportion of the value
of the goods or for 100% of the value of the goods.

Problems Concerning Payments in Advance and Open


Account Trading

Open Account Trading


When selling goods, the exporter has a real risk of not
getting paid. The exporter normally sends a copy of
the invoice either upon shipment or on a monthly
basis, asking the purchaser to arrange to remit the
amount due either on agreed future dates or at the end
of the month following the date of the invoice.
9

Additional Methods of Payment


Forfaiting
It is a facility for financing medium and long-term
contracts for exports of capital equipment. The process
revolves around a specialist market prepared to buy and
sell bills of exchange and promissory notes drawn on
foreign importers and bearing the guarantees of their
central banks. Exporters are able to finance their sales by
non-recourse discounting of those instruments through
forfaiting companies.

Additional Methods of Payment


Countertrade
The creation of deals between importers in countries with
little or no foreign exchange to pay for imports and
exporters prepared to supply them with essential goods.
Payment can be in several forms, part goods or services,
part foreign exchange and part in switch currency. The
deals may involve the movement of goods between a
number of countries before the original exporter is paid.
1

Purchase of Receivables
Purchasing (accounts) receivables provides a means
for exporters to raise cash on debts due or becoming
due to them from overseas buyers. It is a simple
process by which a bank purchases the debts and is
repaid by settlement from the buyers.

Benefits of Documentary Credit

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 banks
credit standing, distinguished from the banks 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
reduces or eliminates the commercial credit risk since payment is assured by
the bank which issues an irrevocable Documentary Credit.
reduces certain exchange and political risks while not necessarily eliminating
them

Benefits of Documentary Credit


May not require actual segregation of cash, since the buyer is not always
required to collateralize his Documentary Credit obligation to the issuing bank.
Expands sources of supply for the buyers since certain sellers are willing to sell
only against cash in advance or Documentary Credit
Provides a specific transaction with independent credit backing of a bank
Provides clear-cut guarantee of payment
Satisfies the financing needs of seller and buyer by placing the banks credit
standing on the transaction
Reduces or eliminates foreign exchange and political risks
Provides the buyer with the assurance that required documents will be received

Unit 4: 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.

Incoterms/Terms Of Delivery/Shipping Terms


If upon formalizing a contract of sale, the buyer and the seller
specifically incorporate one of the shipping terms or incoterms used in
international commerce, they may be assured that they have defined
their respective responsibilities in a simple and unambiguous manner.
This should eliminate any possibility of misinterpretation and
corresponding disputes.
The incoterm rules on the use of domestic and international trade
terms, facilitates the conduct of global trade. it describes mainly the
tasks, the cost and risks involved in the delivery of goods from sellers to
1 buyers.

Incoterms/Terms Of Delivery/Shipping Terms


Incoterms provide generally four pieces of Information
Information on the transfer of risk - It defines at which place
he 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.

Incoterms/Terms Of Delivery/Shipping Terms


Information on the document - It defines who will
provide the required documents
Information on port of shipment and port of delivery
It defines where cargo or goods be loaded and place of
discharge

Incoterms/Terms Of Delivery/Shipping Terms


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.

Incoterms/Terms Of Delivery/Shipping Terms


Incoterms have been around since the first version in
1936 and has seen various revisions. Incoterms are
applicable when there is a physical movement of
goods, and
whilst they are mostly used in
international trade, they can be appropriately used for
domestic trade as well.

Incoterms/Terms Of Delivery/Shipping Terms


In international trade, there are likely to be three separate contracts for the
transportation of goods;
o From the sellers or exporters premises in his/her country to a named point or place in
the importers country
o From the transport operators premises in the exporters country to the named point in
the importers country
o From the port of discharge in the importers country to the importers own factory

Number of Incoterms was reduced from 13 to 11 in 2010


EXW FAS FOB FCA CFR CIF CPT CIP DAF DES DEQ DDU DDP
EXW FAS FOB FCA CFR CIF CPT CIP DAP DAT DDP

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.

Main Changes In The Incoterms 2010


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

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

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

Purpose of Incoterms
Use By 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
Use By 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

Incoterms and Documents

It is not a primary function of Incoterms to dictate what documents are to be


issued, or what their content should be, the following is a precise description of
what the rules state on documents:
CIF/CIP the seller is required to provide the buyer with an insurance
document covering risks from the delivery point to the named point
C and D Terms the seller must provide the buyer with the transport document
or other proof of delivery appropriate to the means of transportation

There are 11 incoterms, subdivided into two categories


o Rules for any mode or modes of transport EXW, FCA, CPT, CIP, DAP, DAT,
DDP
o Rules for Sea and Inland Waterway FAS, FOB, CFR, CIF

Responsibilities
EXW (Ex Works) term defines the minimum that has to be done
from the sellers perspective. The sellers responsibilities end at
making the goods available at the named place where the goods are,
usually at a warehouse or manufacturing point.
DDP (Delivered Duty Paid) term defines the most that has to be
done from the sellers perspective.
The other terms define the points in between these two extremes.

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

Format of Incoterms
The named place started 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
1

Incoterms/Shipping Terms/Trade Terms


Trade terms or shipping terms identify for the parties what to
do with respect to their individual responsibilities. Shipping
goods from one country to another under a commercial
transaction has its risks. If upon formalizing a contract of
sale, the importer and the exporter specifically incorporate
one of the trade terms of delivery used in international trade
they may be assured that they defined their respective
responsibilities in simple and secure manner.

Incoterms/Shipping Terms/Trade Terms


Definition and Purpose of Incoterm
The purpose of incoterms is to provide a set of international
rules for the interpretation of the most commonly used
shipping terms in foreign trade, to avoid different
interpretations of such terms in different countries. The basic
function of the incoterms is to explain how functions, costs
and risks should be divided between the parties in connection
with delivery of goods from the seller to the buyer.
1

Incoterms/Shipping Terms/Trade Terms


In international Trade, both the exporter and the importer
have responsibilities and costs to incur. The critical point is
the point at which the obligation to arrange for further
transport of the goods and to assume further costs and risks
is transferred from the seller to the buyer. It marks the end
of risks and costs assumed by the exporter and the
beginning of risks and costs to be assumed by, the importer,
based on terms of delivery.

Incoterms/Shipping Terms/Trade Terms


Cost Implication
The terms of delivery determine the price quoted for
goods and services in trade. Both the exporter and
importer need to know the precise financial
implications of incoterms so as to be able to sensible
prices and calculate cost.

Incoterms/Shipping Terms/Trade Terms


There are 11 internationally acceptable trade terms/incoterms used in
international trade business in the world. These are:
Ex Works (Aluworks, Tema-Ghana)
Exporter/Seller is responsible for producing the goods and:
o Making them available at the factory premises for the importer
o Providing the buyer with commercial invoice for goods
Buyer/Importer is responsible for:
o Local transport and insurance to the port of loading
o On- and off- loading charges

Incoterms/Shipping Terms/Trade Terms


FAS- Free Alongside Shipping (KINTAMPO, Tema Port)
Exporter/seller must arrange to:
o Deliver the goods at the point and port of loading named in the contract
o 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:
o 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
o Arranging and paying for any export permit or export taxes, excluding value added tax

Incoterms/Shipping Terms/Trade Terms


FOB - Free on board of vessel named carrier/ship (GYATA, Tema Port)
Free on board means that the buyer does not pay for transporting or insuring the goods
from the sellers premises.
The Exporter/seller must:
o Pay for the transportation to the named port of shipment
o Provide and pay for the export license
The Buyer/Importer must:
o Nominate the carrier to carry the goods
o Give the seller/exporter the details of the ship/airline, sailing time, airline flight
time/date

Incoterms/Shipping Terms/Trade Terms


CFR Cost and Freight (named port of discharge, Tema Port)

The seller/exporter must:


o Nominate the carrier and so make the contract of carriage
o Pay for the transportation of the goods to the place of shipment and local
insurance

The buyer/importer must:


o Pay for the marine insurance of goods from the time they are taken on board
to the port of discharge
o Pay for the unloading cost at the destination

Incoterms/Shipping Terms/Trade Terms


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 off-loading charges and:
o Obtain the import license
o Arrange to pay the import duties; and
o Pay for local transport and insurance cost from the port of discharge to
the buyers premises

Incoterms/Shipping Terms/Trade Terms


DDP Delivered Duty Paid (Buyers 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 importers 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
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

Incoterms/Shipping Terms/Trade Terms


Exporter/seller
o delivers the goods on the terminal at the named port of destination
o pays for unloading cost
Buyer/importer
o accepts delivery of goods at named port of destination
o is responsible for local transport, insurance and others

Incoterms/Shipping Terms/Trade Terms


FCA Free Carrier (Boankra Inland Port, Kumasi)
This term is used where inland port is used in the transportation of goods.
The Exporter/seller:
o delivers goods to Boankra inland container depot
o 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
o Arranges for appropriate insurance and obtains policy or certificate
o obtains the import license
o pays for import duties

Incoterms/Shipping Terms/Trade Terms


DAT Delivered at Terminal (Shed One, Tema Port)
This means that the seller delivers when the goods, once unloaded from the arriving
means of transport, are placed at the disposal of the buyer at a named terminal at the
named port of destination.
Exporter/seller
o delivers the goods on the terminal at the named port of destination
o pays for unloading cost
Buyer/importer
o accepts delivery of goods at named port of destination
o responsible for local transport, insurance and others

Incoterms/Shipping Terms/Trade Terms


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:
o Completes export and customs requirements including obtaining any export license
o pays export duties and taxes
The buyer/importer must:
o obtain import license and pay all the import duties, including value added tax
o arrange and pay for insurance for the goods, from time the goods are delivered into the
custody of the carrier.

Incoterms/Shipping Terms/Trade Terms


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

Unit 5: 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

Introduction
Documentation
Documentation in international trade transactions provides tangible evidence
that goods have been ordered, produced and dispatched in accordance with
the buyers requirement or pre-sale 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.

The Impact of Modern Transport on International Trade


The trend towards integrated (door to door) and multi-modal 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 ships rail to seaport or inland
terminals. Consequently, there is a requirement for documents that specify
goods received for shipment.

Transport Documents
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
worlds 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. 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.

The Functions of a Bill of Lading


1) It acts as a receipt for the goods from the shipping company to the exporter
2) It is evidence of the contract of carriage between the exporter and the carrier
3) 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.
4) A bill of lading is a quasi-negotiable document. Any transferee for value
who takes possession of an endorsed bill of lading obtains good title to the
goods.
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.

The Functions of a Bill of Lading


Title to the goods can be transferred by the sender, using a marine bill of lading
in one of three ways:
i.

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
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
iv. The bill of lading will indicate the state in which goods were received for
shipment (clean, dirty or damaged)

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.
o. It has the same function as the ordinary Marine bill of exchange
o. It provides evidence of contract of carriage
o. It serves as receipt for the shipper/exporter.
o. It is a document of title- the holder has Constructive control over the
shipped good.

Types of Bill of Lading


B. Short Form Bill of Lading
This is a bill of lading which does not contain the shipping companys 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 carriers
standard condition.
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.

Types of Bill of Lading


C. 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 importers country.
The goods, although carried by two or more modes of
transport, are shipped under a single contract of carriage.

Types of Bill of Lading


D. 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 ships 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
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Types of Bill of Lading


E. Trans-shipment Bill of Lading
These are used when the goods have been transferred from one vessel to another vessel
at a named trans-shipment port. Once again the carrier has full responsibility for the
whole journey.
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:
o a contract between the shipping company and the exporter or overseas buyer
o a receipt by the shipping company for the goods received and so, provides evidence of
shipment.
A sea waybill is non-negotiable and not a document of title. It is used instead of a bill of
lading.

Other Documents Used In International


Trade
I. Air Way Bill/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.

Other Documents Used In International


Trade
II. 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 non-negotiable nor a
document of title.
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Other Transport Documents


III. 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.
IV. 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.

Commercial Documents
Pro-forma Invoice

Pro-forma 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.
Pro-forma invoices are used for the following purposes:
The overseas buyer might need to present a pro-forma 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

Commercial Documents
They serve as a price quotation and might include the terms of sale
In certain cases, they can be used as a document of tender for an export contract
o 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

Commercial Documents
terms of payment open account, documentary credit or advance payment
method of settlement by swift, telegraphic transfers, mail transfers, foreign
bankers draft
o 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

Commercial Documents
o A Consular Invoice
It is a commercial invoice, which is prepared on a form, printed in the
exporters country by the consulate of the buyers country. The Trade
Attach 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

Commercial Documents
o 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
exporters 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 exporters country.
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Commercial Documents
o Weight Note

This is a document issued by the exporter or third party declaring the weight
of the goods in the consignment.
o Inspection Certificate Pre-Shipment Inspection

This is a certificate issued by an independent third party resident in the


exporters 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.

Commercial Documents
o 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.
o 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.

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. There are
three kinds of marine insurance policies:
Basic named perils sea, jettisons, explosions and hurricanes

Insurance Documents
Broad named perils theft, pilferage, non-delivery, 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. 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.

Insurance Documents
Three basic insurance documents are:
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
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.
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.

Insurance Policy
The insurance policy 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:
o Perils at sea accidental loss or damage caused by sinking, collision, sea water,
heavy weather and stranding
o 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
o Fire, including smoke damage
o Theft forcible theft of goods rather than pilferage
o Damage in loading, trans-shipment or discharge

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

Financial Documents
In international trade, there are two financial documents which
provide for payment by the buyer. These are:
o After a period of credit
o establishing a clear legal undertaking by the buyer to make the
payment either by the Bill of Exchange or promissory note.

Financial Documents
A Bill of Exchange
A bill of exchange is defined by the Bill of Exchange Act 55, 1961 as
o an unconditional order in writing
o addressed by one person to another
o signed by the person drawing it
o 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
o acting to the order of a specified person, or to bearer

Financial Documents
Types of Bill of Exchange
Bills of exchange can be classified in two types:
o 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
o 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. 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.

Financial Documents
Bill of exchange can also be subdivided into:
o 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.
o 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.
o Accommodation bills these are used by banks to provide accommodation
facilities for their clients
o Documentary bills and clean bills

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

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

Unit 6: 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

Introduction
It is the only payment mechanism which usually satisfies the sellers
desire for cash and importers desire for credit

Definition of Documentary Credit or Letter of 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
Banks consideration before issuing Credit
Status report on the beneficiary:
I.

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

II. Such reports could be obtained from the beneficiarys bankers


through the importers correspondent bank network

Documentary Credit

Facilities

oIt constitutes a definite obligation for the issuing bank to pay or


accept against presentation of complaint documents regardless
of whether it is able to reimburse itself or the applicant
o 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.

Parties to the Documentary Credit


1) Applicant/Buyer/Opener The party on whose behalf it is issued
2) Issuing Bank The bank that issues it and acts for the Applicant
3)

Advising Bank The Bank through which documentary credit is conveyed to the
beneficiary

4) Beneficiary the party to whom the documentary credit is addressed and who will receive
payment. Under documentary credit operations, there exists a distant triangular contractual
agreement. That is;
I.

Firstly, the sales contract between Buyer and Seller (proforma arrangement)

II.

Secondly, the Application and Security Agreement or the Reimbursing Agreement


between the Buyer and the Issuing Bank

III. Thirdly, the Documentary Credit between Issuing Bank through the Advising Bank and
the Beneficiary

Documentary Credit Mechanisms


In documentary credit mechanisms, banks deal in documents but not in goods
Article 4 of U.C.P. 500 (uniform customs & practices for documentary credit
1993)

General instructions for opening a


Documentary Credit
o 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
o Types of Credit
I.

Irrevocable Credit incapable of cancellation or modification except with the


consent of the Beneficiary

II. Revocable Credit may be cancelled 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
o.

General instructions for opening a Documentary Credit


o 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
o Negotiation this instruction should be used where drafts are drawn
by the beneficiary on the bank named to negotiate

General instructions for opening a


Documentary Credit
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
o Documents Required details of documents required in
documentary credit should be mentioned in the application
form. It is not sufficient to say usual documents
o Delivery Terms applicant should state the delivery terms
to avoid ambiguities in transport and delivery charges
o

General instructions for opening a Documentary Credit

oGeneral unless the letter of credit states otherwise,


shipping documents bearing reference to other charges in
addition to freight charges will be accepted
o
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

Unit 7: 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 non-traditional facilities provided by
banks in export trade

Introduction
Financing the pre-shipment, or post-shipment period is an important
consideration for any exporter. The method of financing chosen by the
exporter will be influenced greatly by the following factors:
o The terms of trade
o The payment mechanism
o Currency and cash flows consideration
o The cost of funds/pricing
o The availability of any export credit insurance

Introduction
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 . 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.

Introduction
Export finance may be categorized into:
o Short term To finance working capital. Short term finances
normally repaid within 18 months
o Medium term To finance acquisition of semi-processed items.
Facilities that cover 18 to 36 months may be classified as mediumterm.
o 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.
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Pre-shipment and Post shipment Finance


Pre-shipment 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
Post-shipment finance is money required to finance the
exporter between dispatch of goods and receipt of payment
from the importer.

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.

Financing The Trade Cycle


Organizing the finance is an important part of any well-defined
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. Every facility will depend on the payment
mechanism and other criteria such as:
o Customers requirement
o Assessment of risks in the chosen facility

Financing The Trade Cycle


o Terms of trade
o Cost and benefit analysis of the facility
o Expected income to be derived
o Cross-selling of other related services

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
companys 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.

Understanding The Trade Cycle


The bank, through its knowledge of customers 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
customers 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.

Factors that make Export Financing Attractive To Banks


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
Self-Liquidating Nature of Business Repayment from the sale of underlying goods
Security The underlying goods could be used as security
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.

Short Term Facilities Available to Exporters from Banks


Export finance can be classified as traditional and non-traditional banking facilities
Traditional Export Banking Facilities
Non-Traditional Export
Banking Facilities
o Secured/Unsecured Overdraft
Export Factoring
o Loans (Short & Medium)
Invoice Discounting
o Advance Against Collection
o Negotiating
o Sight Payment
o Documentary Credit Acceptance
o Accommodation Finance
o Acceptance Credit
Avalisation

Forfaiting
Leasing
Hire Purchase
Counter Trade
Export Merchant
Confirming House

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.
Overdrafts can be split into two categories:
o Agreed Overdraft:
The agreed overdraft limit falls into two types:
I.

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.

II. Renewable/Revolving Is a facility which is essentially to be used as a standby.

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. 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 customers account to ensure that the
assumptions on which the original limit was marked have not changed.

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

Short Term and Medium Term Loan


o 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. 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.
1

Short Term and Medium Term Loan


o 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. The basic considerations under the Negotiation
facility will be:
Credit Standing of the exporter
Exporters proven track record
Ability to get full control over goods through the documentation

Short Term and Medium Term Loan


Marketing of the goods
Existence of exchange control in the importers country
Whether credit is held
Terms of Payment (i.e. D/A or D.P.)

Acceptance Credit or Accommodation Finance


This facility is where the exporters 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 as a fine
rate.
As a security, the exporters bank obtains authority to take over all
rights to documentary collection, which it submits on the exporters
behalf. The repayment of the acceptance facility will be from the
expected export proceeds under the documentary collection. Such a
facility is granted to n undoubted customer with a proven track record.

Facilities Available Under Documentary Credits


o 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 customers 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.

o 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.

Facilities Available Under Documentary Credits


o Assignment of Proceeds of a Documentary Credit
This is a means of obtaining pre-shipment finance with the cooperation of
the exporters bank. The exporters bank, acting on its customers authority,
issues a letter of comfort to the exporters 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 exporters local suppliers to grant
pre-shipment and post-shipment credit to the exporter.

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.
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.

Green Clause Credit


Green clause credit contains an instructions 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 or
recommended warehouse before payment is made to the beneficiary against a
simple receipt.
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.

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 exporters account.
An eligible bank bill can be discounted at a finer rate. 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.

Non-Traditional Banking Facilities


o 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 cashflows, as
well as savings. Under export factoring, a customers entire turnover is purchased
with or without recourse. The export factoring services are as follows:
I.

Accounting, credit checking and debt collection

II. Credit insurance against bad debts


III. The provision of immediate cash against client invoices up to 75% to 85% of
face value.

Non-Traditional Banking Facilities


Factoring Contd
Customer Benefit of Export Factoring
I.

Cash-flow is more predictable because the client knows that he can claim up to 85% as
immediate advance against his invoices

II. Bad debt losses are eliminated from those debts that have been factored
III. Sales ledger administration is reduced because sales ledger accounting cost is taken off
IV. Foreign exchange risk may be eliminated if invoices are quoted to foreign currencies
V. Managements time is used efficiently because they can concentrate on production and
sales
VI. 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 use the right to
advance against the invoice

Non-Traditional Banking Facilities


o 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 exporters 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.
Benefits of Invoice Discounting
I.

Invoice discounting is not disclosed to the debtors of the factor client

II. Under invoice discounting, the client does not run his own accounts ledger
III. This facility is useful when the client has an efficient sale ledger team of his own
IV. Cashflow is improved and management could concentrate on production.

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 semi-consumable goods, semi-capital, 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 importers
bank.

Forfaiting
Advantages of Forfaiting to Exporters
I.

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

II.

The exporters liquidity and cashflow are improved because he


receives cash at once

III. Enhances the customers borrowing capacity

Forfaiting
Disadvantages to the Exporter
I.

Costs can be high and there is no interest rate subsidy

II. It may be difficult to find an institution which will be prepared to


guarantee the importers liabilities
III. There is possibility that the government of the buyers country may
impose foreign exchange controls

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
equipments life.

Leasing
Leasing can be made available to the foreign buyer:
o Either by arranging finance from the exporters country into the
lessees country (cross-border leasing)
o by arranging the leasing in the buyers country through an
international contract of a leasing company in the exporters 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
2

Leasing
The advantages of the second method:
I.

Leasing could be arranged for the delivered cost of the equipment


or plant

II. The terms of the lease might be longer than a cross border leasing
III. 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

Hire Purchase
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:
o By an arrangement with the hire purchase company in the exporters country which
has a branch office in the buyers company
o By an arrangement with a hire purchase company in the exporters country which is
a member of the International Purchase Credit Union
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.

Avalisation Avalised Bills Facility


Avalisation involves aiding the lenders 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 bankers to
unconditionally guarantee a debt to an overseas supplier. Avalising is
mainly used when dealing with European suppliers. 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.

Avalisation Avalised Bills Facility


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.

Counter Trade
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
Counter-purchase
Bilateral agreements using clearing accounts
Switch trading
Tolling
Co-operation agreements
Build-operative-transfer

Export Merchants
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 suppliers own currency. 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.

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.

Unit 8: Import Financing


Objectives
o To distinguish between Buyer and Supplier Credit
o To describe the types of credit available to the importer
o To explain the specialized facility available to importers
o To help students to know the usage of Standby Letter of Credit
Facilities

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
importers resources. Such a situation may require some kind of financial
assistance.
Seasonal peaks, long transit times and lengthy credit terms may all
compound the importers liquidity problem, which may require bridging
up financing. It is important that the finance to meet the seasonal
fluctuation of the importers working capital requirements be geared
towards the terms and method of pre-payment agreed between supplier
and buyer.

Buyer and Supplier Credit


Buyer credit facility involves a loan from a local bank 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 involves the exporters bank lending money to the
exporter, to provide post-shipment finance.
.

Buyer and Supplier Credit


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.
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
2

Buyer and Supplier Credit


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.

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. By offering
to settle import bills immediately, importers my be able to negotiate
better terms or prices with their suppliers.

Import Loans
Where credit is taken from the supplier, the facility can be used to
meet the importers 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.

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. Thus, the
importer may require finance to bridge the gap between sight payment and receipt of funds
from the third party.
Procedure for Produce Loan
o 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

Product Loans or Warehousing Facility


o When the shipping documents are received, they will be pledged as security to the bank
o 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
o The bank will debit a produce loan and credit the customers current account with the
agreed amount of the advance
o 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
o The goods should be insured at the expense of the importer
o The goods remain in the warehouse until the time comes for delivery to the ultimate
buyer.
o The ultimate buyer pays directly to the lending bank and the proceeds are used to clear
the produce loan, including interest and charges.

Acceptance Credit facility/Accommodation Facility


Bankers acceptances are facilities granted by banks to enable importers to pay
the exporters, pending the sale of goods.
The importers 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.
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.

Import Financing
Documentary Credit Facilities
When a bank issues an irrevocable documentary credit, it conditionally
guarantees a consumers 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 buyers 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.

Goods as Collateral Security


The lenders liability under a documentary credit facility can be secured
by goods being imported, provided control can be exercised over the
goods and there will be ready market for them should the importer not be
able to meet the obligation. Since a bank issuing a documentary credit
will be guaranteeing payment to the overseas supplier, it must have some
protection and if the importers credit facilities are fully extended, the
bank might be able to obtain protection in terms of the import transaction
itself, under acceptance or deferred payment.
Payment for the imported goods will receive tenor so that proceeds from
the resale would be used in the payment of the bill on maturity.

Documentary Credits Payable After Sight But Which


Contain A Negotiation Clause

If an exporter insists on documentary credit, there could be a problem


if he requires payment immediately and the importer requires credit
term at the same time. One possible answer is a term bill which
contains an authority for the advising bank to negotiate against correct
presentation of documents.

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 non-performance.
It stipulates that a sum of money will be paid to the beneficiary in the
event of default or non-performance. 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.

Standby Letter of Credit


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

Standby Letter of Credit


Benefits to the Applicant
o Avoids the need to transfer funds to an overseas subsidiary
o Enables provision of security where exchange control prohibits or restricts transfer of
funds
o Used to guarantee the issue of bid, performance, advances payment bonds
o 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
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.

Unit 9: 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

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. 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.

Introduction
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.

Payment by Cheque
This is a method of settlement in international transactions where the payees
account is credited when the drawers bank clears the cheque presented by the
payee.
Procedures
o A U.K. buyer draws a cheque in favour of a Ghanaian exporter and then posts
the cheque to the Ghanaian exporter
o The Ghanaian will then present the cheque to his local banker, who will in turn
present it to the drawees bank for payment
o On receipt of funds from the buyers bank in the U.K., the Ghanaian bank will
credit the exporters foreign currency account or foreign exchange account.

Exchange Account less Handling and Collecting Charges


Payment by cheque of a debt in international trade might also unsatisfactory for the
following reasons:
o The exporter or payee will have to ask his local bankers to arrange to collect the payment
and possibly incur handling and collection charges
o The cheque could be stolen or lost in the post thereby causing delays on the part of the
exporter or payee
o The cheque may be returned and not paid when presented
o Postal/courier services are said to be slow when one considers the effective usage of the
funds
o The cheque might contravene the exchange control regulations of the drawees country
therefore settlement could be delayed

Payment By Bankers Draft or International Bankers Draft


An international bankers draft is a cheque drawn by one bank on its correspondent bank
overseas. This method is particularly suitable for non-priority, 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
Procedures
o Supposing that a company in Ghana wishes to pay off a supplier in the UK for 20,000
by means of a bankers 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 bankers draft for 20,000
o The Ghanaian bank debits the companys account with the cedi equivalent plus
commission or debits the foreign currency account and gives the bankers draft to the
companys representative.

Payment By Bankers Draft or International Bankers Draft


o The bankers draft will be sent to the supplier in the UK

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

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 bankers draft;
and is sent by airmail. Mail payment is best used only for nonpriority, low value transactions.

Mail Transfer
Procedures For A Mail Transfer
o 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
o The local bank then sends instructions to its correspondent bank in
UK giving details of payment

Mail Transfer (M/T)


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 bankers draft at no extra cost.

Telegraphic/Cable Transfer
Telegraphic/Cable Transfers
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

SWIFT (Society For Worldwide Interbank Financial


Telecommunications)
This is a co-operative 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.
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.

SWIFT (Society For Worldwide Interbank Financial


Telecommunications)

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

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 non-priority.

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.

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.
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.

Book-keeping for Transfer of Funds


When a local bank customer wishes to transfer funds denominated in
foreign currency, the booking is:
o 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.
o 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.

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.

Controlling The Balances On Nostro Accounts


To exercise good control over nostro, a bank must obviously keep a
careful record of its transaction;
o Items passing through the nostro accounts should be value-dates items
o Periodic statements should be sent to enable the overseas banks
reconcile promptly
o For each liability, the date on which it is expected that the nostro
account will actually be debited with the payment should be monitored

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 with within a relatively short
time for effective cash management.
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.

International Cash Management Facilities


Some of the features on these systems are:
o 24 hour/365 day access to balances and transaction details on foreign currency accounts held
anywhere in the group
o Provision of L/C facilities L/C facilities can be created quickly from pre-stored templates and
libraries of data customized to specific needs.
o Fast movement of funds between accounts
o Current and projected cashflow reporting
o Comprehensive search facilities
o Extensive balance history information
o Customized reporting and download of information to software packages
o Global Exchange rates and interest information
o Up-to-date reports on World Economies and financial markets

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.
The under-listed instances are some of the features of money laundering business:
o 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.

General Problems Associated with International Fund


Transfers

o Attempt to transfer money in contravention of internationally agreed


sanctions
o Stealing and transferring state funds into private accounts overseas by
public and state officials
o Transfers that would contravene the laws of other countries. For
example, payments for export which the exporters government has
banned by law
o Requests for customers to pass message to overseas businesses,
usually by means of telex

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.
Forged bankers 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 beneficiarys 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 buyers government.

Know Your Customer 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. 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

Unit 10: Travel Facilities And Non-financial


Services
Objectives
To discuss various services and facilities provided by Banks
To describe various travel facilities available and discuss the
advantages and disadvantages
To assist students to understand limitations involved in the various
methods of providing funds for travelers
To help students to know currency regulations in overseas countries

Introduction
Traveling is a bigger business in the European, American, Asian and Far East countries
than in the West African sub-region, but increasingly governments in the sub-region are
trying to improve infrastructure and facilities to attract more tourists. Banks in the subregion are also providing more traveling facilities for the traveling public.
It is important to understand not only the arrangements which might be used to assist
travelers, but also the most appropriate in view of the individuals circumstances and
need.
Matters to be considered will depend on:
o Length of stay abroad
o amount of money required
o Convenience for the individual seeking the loan

Introduction
o The speed at which money has to be made available
o Exchange control regulations and restrictions
o Country being visited
o Why the money is needed
o Travelers are entitled to an equivalent of 10,000 USD as per Bank of
Ghana notice

Facilities Available for The Traveling Public By Banks:


Foreign Currency Notes and Coins
Foreign bank notes and coins might be required by a traveler going abroad. The
local bank may obtain foreign notes and coins either through importation, with
the cost of freight and insurance paid by the importing bank or exchange the
bank notes and coins of overseas travelers visiting.
Advantages of Foreign Notes and Coins To The Overseas Traveler
o The travelers are protected against any adverse movement in the exchange
rates
o The traveler avoids the inconvenience of queueing at a bank overseas to obtain
foreign currency
o The traveler is able to pay for his expenses as he incurs them

Facilities Available for The Traveling Public By Banks:


Foreign Currency Notes and Coins

Disadvantages of Foreign Notes and Coins


o The money may be lost or stolen and the traveler would lose
everything
o Notes and coins might be bulky to carry around
o If the traveler leaves Ghana on short notice, he might not be able to
obtain foreign currency from the bank within the time available
o The overseas government may impose exchange control limit on an
amount a traveler can take in and out of the country

Travelers Cheque
A traveler might take a travelers cheque to cover all expenses up to $3,000 or its
equivalent in other major currencies
Advantages of Using Travelers Cheque
o The travelers cheque is easy to carry
o The cheque is convenient to handle
o They can be exchanged in any country for the local currency of that country
o In the case of theft or loss, the issuing bank will refund the money, provided it is
notified of the loss straight away
o They might be cashed not only at banks overseas, but at hotels, shops, restaurants
and other businesses

Travelers Cheque
Disadvantages of Using Travelers Cheque
o They might be inconvenient to carry around if the traveler requires
large amount of money during his stay abroad
o They may be stolen during the clients stay abroad
o In some countries of the world, particularly in the U.S. travelers
cheques are not widely accepted

ECOWAS Travelers Cheque


Travelers in the West African sub-region could use the ECOWAS travelers cheques to
pay for their travel expenses. ECOWAS travelers cheques are issued by ECOWAS
Central Banks jointly and are managed by the West African Monetary Agency. The
ECOWAS travelers cheques are to encourage trade among members in the sub-region
to help member states to conserve foreign exchange and boost tourism among member
countries.
Advantages of ECOWAS Travelers Cheque
o They are easy to handle
o They are sold by the commercial and merchant banks branches in countries, making it
easier for travelers to access
o Issuing banks will refund the money in the case of theft or loss

ECOWAS Travelers Cheque


Disadvantages of ECOWAS Travelers Cheque
o Patronage is very low- it is not recognized or accepted by most hotels
and restaurants within the sub-region
o Usage is restricted to the West African sub-region only
o There are inherent risks in exchange rate fluctuation

Euro Cheque Card Scheme/ Euro Cheque Encashment


Card
Euro-cheque cards guarantee payment up to the foreign exchange equivalent of 100,
but there is a limit as to the number of cheques issued out per transaction
The Euro cheque can be also be used to obtain cash and make payment in retail
outlets
Euro cheque encashment card system operates as follows:
o A UK traveler expecting to travel abroad who thinks he might want to cash cheques
while abroad must apply to a local bank for a Euro cheque encashment card
o The bank will then provide a card with expiry date
o The card can only be used for cashing cheque and must be used at a bank in
overseas where the Euro cheque system can be accessed

Euro Cheque Card Scheme/ Euro Cheque Encashment


Card

Advantages
o Euro cheques are guaranteed to the currency equivalent of 100 per
transaction.
o It is safer to carry, in relation to cash
o They can be used by a customer to draw on personal current accounts
in overseas countries.
o It makes payment of bills easier because it is accepted by
approximately 10 million businesses worldwide

International Credit/Debit Cards


Debit and credit cards are mostly used by travelers because of their
convenience and security.
Credit Cards
Travelers use credit cards like Visa or Master Cards in payment of bills, and
sometimes to obtain cash in times of emergencies. These credit cards could be
used for the payment of goods and services, as well as obtaining cash, provide
that the traveler has not exceeded his or her credit ceiling. These cards are
widely used in Europe, America, Japan, Middle East, Asia, and South Africa.
Debit Cards
Debit cards are known as charge cards. They are obtained from the card issuing
organizations on payment of an initial fee and yearly subscription charge.

International Credit/Debit Cards


The credit cards may have a spending limit on them depending on the individual
card holder, but the debit cards cannot be used for extended credit because the
card holder is supposed to reimburse the issuing card organization fully of receipt
of monthly statement of expenditure. Banks in Ghana do offer cards to their high
net-worth clients.
Advantages of The Card System
o It is very safe and convenient
o Credit cards can be replaced almost immediately, in the case of theft or loss

International Credit/Debit Cards


Disadvantages of Card System
o The cards are not widely accepted in the West-African sub-region
o Exchange control makes it impossible to utilize the cards effectively
o Undeveloped communication infrastructure in the West-African subregion impedes the growth of the system

Other Travel Facilities


Opening Up A Bank Account Overseas

If a person intend to go overseas, his local bankers can introduce him to the
overseas correspondent bank to open an account for their respectable clients.
Open Credit Facilities

A local bank make prior arrangement on behalf of its customer with specified
bank overseas whereby a particular branch of the overseas bank will cash cheques
for that customer for a specified or up to a maximum total credit limit
Such facilities are appropriate in certain parts of the world. The local bank sends a
specimen signature of the customer to the overseas bank and the customer will
cash his cheques at a specified branch, obtaining foreign currency.

Other Travel Facilities


Advantages of an Open Facility
o It avoids the need to carry travelers cheques
o Cash can be drawn as and when the traveler requires it.

Other Travel Facilities


Emergency Funds Arrangement
In an emergency, funds can be transferred abroad by telegraphic transfer or Urgent Swift
message to a customer overseas. The emergency funds could be cabled to a specified
branch of the overseas or correspondent bank, especially in the case of customer being
stranded. Many banks now have dedicated helplines to help in emergency situations.
The remitter will be required to supply the following details to make encashment easier:
o Full name of the beneficiary
o Full address of where the beneficiary resides
o The amount of funds required
o If possible, the name and address of a local bank to which funds should be remitted.

Letters of Introduction
An overseas bank can introduce a traveler or customer to a company, government
department or local council of the area where the traveler or customer wants to do
business. A Ghanaian bank can provide a letter of introduction to an overseas
correspondent bank which would then offer suitable assistance to the traveler or
customer.
The advantages of Letter of Introduction are:
o The customer is more easily identified and he is likely able to meet potential
customer or prospective agents
o The person being approached is assured that the customer is a person of high
integrity with good business credibility, having been introduced by a reputable bank.

Travel Insurance
Banks, in conjunction with the insurance companies, provide travel insurance for their
clients traveling abroad. This type of insurance will cover medical costs, loss of tickets,
travelers cheques or delay of flight whilst on overseas trip. For example, travelers
visiting France are required to have medical insurance with a provident insurance
company before a visa will be issued by the French Consulate in Ghana
Payment By Mall Transfer/Telegraphic Transfer (S.W.I.F.T)
If a person in Ghana wishes to send funds to another person abroad, he or she can arrange
for payment by mail transfer, telegraphic transfer or SWIFT, provided the transfers are
supported by the relevant documentation. Funds could be also be transferred freely if the
Ghanaian customer operates a foreign currency account with any of the Ghanaian local
banks, otherwise approval would have to be sought from an authorized dealer bank.

Bankers Draft at a Named Correspondent Bank


If a company wishes to make funds available to one of its employees traveling
abroad, it can arrange for a bankers draft to be sent to the overseas bank on behalf
of the employee. The employee can then obtain cash payment at a named
correspondent bank overseas.
Banks Assistance to Potential Exporters
Before entering into the export market, the client should conduct due diligence in
the following areas:
o Marketability of Product/Market Research
o Pricing
o An additional cost, i.e. packaging, shipping and insurance

Bankers Draft at a Named Correspondent


Bank
o Tariffs, Quotas, Import Duties, Value Added Taxes
o Direct selling, Marketing through an agent, international licensing or
international franchising and joint venture
o Exchange Control regimes/Legal matters

Services Offered to Potential Exporters


Banks offer a wide range of services to both existing and potential exporters.
o Status report on potential buyers and agents
o Overseas documentary requirements
o Information on any exchange control restriction on payment by overseas
government
o Advice on the meaning and significance of delivery terms
o Advice on the significance of the various methods of payment for exporters
o Advice on the exchange risk, together with appropriate methods of reducing the
risks Forward contract, Currency option, Currency borrowing and foreign
currency accounts.

Services Offered to Potential Exporters


o Political and economic report on various overseas countries to help
the exporter to decide upon the economic prospect
o Letters of introduction to overseas banks which may have detailed
knowledge of the market.

EXCHANGE
RATES/FOREIGN
EXCHANGE MARKETS

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.

When did Ghana start using the floating exchange rate


regime?

Question.

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.

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.

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..

.. 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.

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.

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.

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,
risk exposure.

it may not appear to have any interest rate

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 ..

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.

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.

Also if the exchange rate between the Ghana cedi and the British
pound is Gh2.25=1, this means that 1 will cost Gh2.25.
Taking the reciprocal, Gh1 will cost 44.44pence.
Besides, if the exchange rate between the Ghana cedi and the U.S
dollar is Gh1.45=US$1.00, this means that, US$1 will cost Gh
1.45. Taking the reciprocal, Gh1 will cost 68.96cent.

The standardized forms of expression are:


-US$/: 1.44,

Or
-US$1.44/,

Gh/:2.25,

Or
Gh2.25/,

Gh/US$:1.45

Or
Gh1.45/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 16th August 2001, the more accurate
rate is US$1.4431/

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 16th
August 2001 were:
(Sell rate)

(Buy rate)

Bid Rate

Offer Rate

US$/

1.4430

1.4432

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
1.4432

= 692,905

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

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).

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?

Answers:
200,000 = US$179,083
1.1168
2)
3)

4000, 0000 1.1173 = 4,469,200


800,000

= US$ 716,012

1.1173
4)

240,000 1.1168 = 268,032

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.

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.

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 worlds
currencies e.g. Dollar, Pound Sterling, Euros, Hong Kong Dollar,
Singaporean Dollar, South African Rand, Japanese Yen, Canadian
Dollar, Kroner etc.

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.

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

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.

Ghanaian Example:
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 = GH198, 326.1
2.5211

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
2.7000

= 185,185.18

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.

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
movements 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 groups financial statements.

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:

a) The Balance Sheet effects:


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

For example: if a UK Company acquires


Gh1, 000,000 of Assets in Ghana when the rate of exchange is GH
2.2/, this can go into the UK groups accounts at a value of
454,545.
If over the course of the next year, the Ghanaian cedi falls against the
sterling to GH2.7/, 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.

b) The profit and loss account effect


Currency changes can have an adverse impact on the groups
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.

3 ECONOMIC RISK

A companys 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.

Two ways

in which competitive position can be undermined by


forex changes.

a)Directly
If your firms 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.

b) Indirectly

Even if your home currency does not move adversely vis -a - vis your
customers 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.

MANAGEMENT OF INTEREST RATES & EXCHANGE RATES


RISKS

a) -Internal Management of Interest rate risk


b)-Internal Management of Exchange rate risk

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 companys balance
sheet.

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

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.

Disadvantages of smoothing
1) This hedging method reduces the comparative advantage
a company may gain by using fixed rate debt I preference
to floating rate debt and vice versa.
2) On top of this, the company may incur two lots of
transaction and arrangement costs.

Contd
Matching:
This hedging method involves the internal matching of
liabilities and assets which both have a common interest rate.

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 subsidiarys borrowing cost increases while


the others returns increase: the interest rates on the assets
and liabilities are matched.

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.

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.

TECHNIQUES DISCUSSED

Matching:
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.

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.

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.

Contd
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.

..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.

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.

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.

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.

..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.

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

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.

..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., .

. 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.

.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.

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.

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.

MANAGING ECONOMIC
RISK(OPERATING EXPOSURE)
Economic exposure is concerned with the long term effects of forex
movements on the firms 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.

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.

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.

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.

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.

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

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).

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 (FRAS) 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.

Forward Exchange Contracts (FECS)

enable companies to fix, in advance, future exchange rates


on an agreed quantity of foreign currency for delivery or
purchase on an agreed date.

FORWARD EXCHANGE CONTRACT EXAMPLE (COVERING


USING THE FORWARD MARKETS)
Suppose that on 15th 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 =3,125,000
1.3984
The UK firm bases its decision on the profitability of the deal
on this amount expressed in pounds.

FEC Contd

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:

FEC Contd
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 euros 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

FEC Contd
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 15th November for delivery of currency
in February).
If the forward rate available on 15th 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.

FEC Contd
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.
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.

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.

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.

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.


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.

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.

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 FRAs are
agreed for three-month periods. So this company could have
two separate FRAs for the year. It would agree different rates
for each three-month period with two different banks, e.g, bank
A and bank B.

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.

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.

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).

f) If Z is the amount of dollars to be borrowed now, then:


Z1.0175 = $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

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.

4) In three months, receive $180,000 from customer.


5) Pay lender $180,000

END OF SLIDES