A quick guide to Trade Finance Instruments

1. Trade Finance
Instruments

2. Cash in Advance
• With cash-in-advance payment terms, the exporter can avoid
credit risk because payment is received before the ownership
of the goods is transferred.
• Wire transfers and credit cards are the most commonly used
cash-in-advance options available to exporters. However,
requiring payment in advance is the least attractive option for
the buyer, because it creates cash-flow problems.
• Foreign buyers are also concerned that the goods may not be
sent if payment is made in advance. Thus, exporters who insist
on this payment method as their sole manner of doing
business may lose to competitors who offer more attractive
payment terms.

3. Letter of Credit
• One of the most secure instruments available to international
traders.
• An LC is a commitment by a bank on behalf of the buyer that
payment will be made to the exporter, provided that the
terms and conditions stated in the LC have been met, as
verified through the presentation of all required documents.
The buyer pays his or her bank to render this service. An LC is
useful when reliable credit information about a foreign buyer
is difficult to obtain, but the exporter is satisfied with the
creditworthiness of the buyer’s foreign bank.
• An LC also protects the buyer because no payment obligation
arises until the goods have been shipped or delivered as
promised.

4. Documentary collection
• A documentary collection (D/C) is a transaction whereby the
exporter entrusts the col-lection of a payment to the remitting bank
(exporter’s bank), which sends documents to a collecting bank
(importer’s bank), along with instructions for payment.
• Funds are received from the importer and remitted to the exporter
through the banks involved in the collec-tion in exchange for those
documents.
• D/Cs involve using a draft that requires the importer to pay the face
amount either at sight (document against payment) or on a specified
date (document against acceptance).
• The draft gives instructions that specify the documents required for
the transfer of title to the goods. Although banks do act as
facilitators for their clients, D/Cs offer no verification process and
limited recourse in the event of non-pay-ment. Drafts are generally
less expensive than LCs

5. Bank guarantee
• A guarantee from a lending institution ensuring that the
liabilities of a debtor will be met.
• In other words, if the debtor fails to settle a debt, the bank
will cover it.
• A bank guarantee, like a line of credit, guarantees a sum of
money to a beneficiary. Unlike a line of credit, the sum is only
paid if the opposing party does not fulfill the stipulated
obligations under the contract. This can be used to essentially
insure a buyer or seller from loss or damage due to
nonperformance by the other party in a contract.

6. Bill of Exchange
• A non-interest-bearing written order used primarily in
international trade that binds one party to pay a fixed sum of
money to another party at a predetermined future date.
• Bills of exchange are similar to checks and promissory notes.
They can be drawn by individuals or banks and are generally
transferable by endorsements.
• The difference between a promissory note and a bill of
exchange is that this product is transferable and can bind one
party to pay a third party that was not involved in its creation.
• If these bills are issued by a bank, they can be referred to as
bank drafts. If they are issued by individuals, they can be
referred to as trade drafts.

7. Difference between Letter of
Credit and Bank Guarantee
• Similar but are two different instruments
L/C:
• Obligation taken by a bank once a certain conditions are met
• After the conditions are met the bank transfers the funds
L/G
• Like a line of credit, guarantees a sum of money to a beneficiary
• The sum is only paid if the opposing party does not fulfill the
stipulated obligations under the contract