Fundamentals of Multinational Finance, 4e (Moffett)

Chapter 19 International Trade Finance

Multiple Choice and True/False Questions

19.1 The Trade Relationship

1) The exporter-importer relationship to a corporation of a foreign importer that has not previously
conducted business with the firm would be an
A) unaffiliated known.
B) affiliated party.
C) unaffiliated unknown.
D) any of the above.
Answer: C
Diff: 1
Topic: 19.1 The Trade Relationship
Skill: Recognition

2) Which of the following relationships between importing and exporting parties would require the least
detailed contract to conduct business?
A) affiliated party
B) unaffiliated unknown party
C) known unaffiliated party
D) domestic supplier
Answer: B
Diff: 1
Topic: 19.1 The Trade Relationship
Skill: Recognition

3) Polaris Corporation has made an agreement to ship goods to a foreign firm with whom they have not
entered into a contract for three years. However, the firms have communicated regularly since the last
sale three years ago. This is an example of an
A) unaffiliated known party transaction.
B) unaffiliated unknown party transaction.
C) affiliated party transaction.
D) none of the above.
Answer: A
Diff: 1
Topic: 19.1 The Trade Relationship
Skill: Conceptual

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4) Today, international trade is dominated by transactions between unaffiliated parties (known or
unknown).
Answer: FALSE
Diff: 1
Topic: 19.1 The Trade Relationship
Skill: Recognition

5) Because most international transactions are between affiliated parties, international transaction
contracts are less complex, but the management of the total value of the MNE is more complex.
Answer: TRUE
Diff: 1
Topic: 19.1 The Trade Relationship
Skill: Recognition

19.2 The Trade Dilemma

1) The risk of default on the part of the importer is present as soon as

A) a price quote is requested.
B) goods are shipped.
C) the export contract is signed.
D) goods are received.
Answer: B
Diff: 1
Topic: 19.2 The Trade Dilemma
Skill: Recognition

2) A fundamental problem of international trade is

A) authorities in the importing country may disallow the consular invoice.
B) authorities in the exporting country may refuse to issue a consular invoice.
C) buyer and seller may act in collusion.
D) buyer and seller may not completely trust each other.
Answer: D
Diff: 1
Topic: 19.2 The Trade Dilemma
Skill: Recognition

19.3 Letter of Credit (L/C)

1) A signed ________ is issued by the exporter and contains a precise description of the merchandise.
A) packing list
B) bill of lading
C) commercial invoice
D) banker's acceptance
Answer: C
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

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2) ________ may be required so that the contents of containers can be identified, either for customs
purposes or for importer identification of the contents of separate containers.
A) Banker's acceptances
B) Commercial invoices
C) Consular invoices
D) Packing lists
Answer: D
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

3) ________ is the risk that interest rates will change between signing the contract and payment for
goods and services.
A) Currency risk
B) Risk of non-completion
C) Default risk
D) Portfolio risk
Answer: A
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

4) A letter of credit is an agreement by the bank to pay against documents rather than the actual
merchandise.
Answer: TRUE
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

5) Which of the following is NOT true regarding a letter of credit?

A) The importer and exporter agree on a transaction.
B) The importer applies to its local bank for the issuance of a letter of credit.
C) The exporter applies to its local bank for the issuance of a letter of credit.
D) The importer's bank cuts a sales contract based on its assessment of the creditworthiness of the
importer.
Answer: C
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

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6) A/An ________ letter of credit is intended to serve as a means of arranging payment, but not as a
guarantee of payment.
A) irrevocable
B) revocable
C) confirmed
D) unconfirmed
Answer: B
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

7) A/An ________ letter of credit is an obligation only of the issuing bank whereas other banks honor
a/an ________ letter of credit.
A) irrevocable; unconfirmed
B) revocable; confirmed
C) confirmed; irrevocable
D) unconfirmed; confirmed
Answer: D
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

8) The primary advantage of a letter of credit is that it reduces risk.

Answer: TRUE
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Conceptual

9) A letter of credit that is confirmed in the ________ country has the additional advantage of
eliminating the problem of ________.
A) exporter's; portfolio risk
B) importer's; blocked foreign exchange
C) exporter's; blocked foreign exchange
D) none of the above
Answer: C
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

10) The major advantage to the exporter of a letter of credit is that the exporter does not receive any
funds until the documents have arrived at a local port or airfield.
Answer: FALSE
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

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11) The letter of credit is designed to
A) allow the buyer to obtain title to the goods before they are received.
B) free the seller from concerns over the payment abilities of the buyer.
C) free the seller from any merchandise guarantees.
D) be issued by the bank at the request of an exporter.
Answer: B
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

12) Which are NOT types of letter of credit?

A) insurable vs. noninsurable
B) confirmed vs. unconfirmed
C) revocable vs. irrevocable
D) None are letters of credit.
Answer: A
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

13) An instrument issued by a bank, at the request of an importer, in which the bank promises to pay a
beneficiary upon presentation of specified documents is a
A) time certificate of deposit.
B) time draft.
C) sight draft.
D) letter of credit.
Answer: D
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

14) The disadvantages of a letter of credit to the importer include

A) the exporter's reduced line of credit as a result of the letter of credit.
B) the fee charged by the exporter's bank for accepting the letter of credit.
C) the fee charged by the importer's bank for issuing the letter of credit.
D) All of the above.
Answer: C
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

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15) When a confirmed letter of credit is used, the exporting firm gains because
A) the government in effect subsidizes shipping costs.
B) the time involved in shipping is generally reduced.
C) the firm can sell against the promise of a local bank rather than a firm.
D) the exporting firm is considered of higher risk.
Answer: C
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Conceptual

16) In a letter of credit, the bank substitutes its credit for that of the importer and promises to pay if
certain documents are submitted to the bank.
Answer: TRUE
Diff: 1
Topic: 19.3 Letter of Credit (L/C)
Skill: Recognition

19.4 Draft

1) A ________ is issued to the exporter by a common carrier transporting the merchandise.

A) commercial invoice
B) banker's acceptance
C) packing list
D) bill of lading
Answer: D
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

2) Which of the following documents is NOT part of a system designed to protect both the importer and
exporter from non-completion of trade?
A) letter of credit
B) draft
C) bill of lading
D) All of the above are important protective documents.
Answer: D
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

3) The draft is the instrument normally used in international commerce to

A) transfer product.
B) prove ownership.
C) transfer title.
D) initiate the sale.
Answer: C
Diff: 1
Topic: 19.4 Draft
Skill: Recognition
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4) The ________ is the instrument normally used to actually effect payment in international commerce.
A) banker's acceptance
B) bill of exchange
C) bill of lading
D) letter of credit
Answer: B
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

5) The person or company initiating the draft or bill of exchange is known as the ________.
A) maker.
B) drawer.
C) originator.
D) any of the above.
Answer: D
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

6) The person or company to whom the draft or bill of exchange is addressed is the ________.
A) drawee.
B) drawer.
C) maker.
D) originator.
Answer: A
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

7) Which of the following is NOT a requirement for a draft to become a negotiable instrument?
A) It must be payable to order or to bearer.
B) It must be payable on demand or at a fixed or determinable future date.
C) It must be in writing and signed by the maker or drawer.
D) All of the above.
Answer: D
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

8) A sight draft is payable on presentation to the drawee; a time draft allows a delay in payment.
Answer: FALSE
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

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9) ________ drafts are unaccompanied by any other documents, and are usually used between MNEs
and ________.
A) Clean; new trading partners
B) Documentary; their own affiliates
C) Clean; their own affiliates
D) None of the above
Answer: C
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

10) Most drafts in international trade are "clean."

Answer: FALSE
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

11) Drafts that have been accepted by banks become

A) clean drafts.
B) nonmarketable.
C) banker's acceptances.
D) none of the above.
Answer: C
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

12) A bill of exchange or draft drawn on a bank and commonly used to guarantee exporters that they
will receive payment on goods delivered to importers is a/an
A) banker's acceptance.
B) clean draft.
C) bill of lading.
D) letter of credit.
Answer: A
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

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13) An exporter has just received a banker's acceptance created by an international transaction. If the
banker's acceptance has a face value of $250,000 and the bank charges a commission of 1% per annum,
how much will the exporter receive from the banker if the acceptance is held until maturity six months
from today?
A) $250,000
B) $247,500
C) $248,750
D) $1,250
Answer: C
Diff: 1
Topic: 19.4 Draft
Skill: Analytical

14) An exporter has just received a banker's acceptance created by an international transaction. If the
banker's acceptance has a face value of $250,000, current rates on banker's acceptances are 6%, and the
bank charges a commission of 1% per annum, how much will the exporter receive if he sells the
acceptance in the secondary market six months prior to maturity?
A) $250,000
B) $244,000
C) $242,500
D) $241,250
Answer: D
Diff: 1
Topic: 19.4 Draft
Skill: Analytical

15) Which of the following purposes is NOT served by the bill of lading?
A) It acts as a receipt.
B) It acts as a contract.
C) It acts as a document of title.
D) It acts as all of the above.
Answer: D
Diff: 1
Topic: 19.4 Draft
Skill: Recognition

16) A straight bill of lading is most likely to be used under which of the following circumstances?
A) when the merchandise has not been paid for in advance
B) when the transaction is being financed by a bank
C) when the shipment is to an affiliate
D) none of the above
Answer: C
Diff: 1
Topic: 19.4 Draft
Skill: Conceptual

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19.5 Government Programs to Help Finance Exports

1) The Foreign Credit Insurance Association is a branch of the U.S. federal government.
Answer: FALSE
Diff: 1
Topic: 19.5 Government Programs to Help Finance Exports
Skill: Recognition

2) The three parties to a letter of credit are

A) issuing bank, seller, and applicant.
B) importer, exporter, and shipping company.
C) notary public, importer, and importer's bank.
D) Ex-Im bank, commercial bank, and importer.
Answer: A
Diff: 1
Topic: 19.5 Government Programs to Help Finance Exports
Skill: Recognition

3) A banker's acceptance is a ________ that has been accepted by a bank.

A) credit certificate
B) time draft
C) line of credit
D) bill of lading
Answer: B
Diff: 1
Topic: 19.5 Government Programs to Help Finance Exports
Skill: Recognition

19.6 Trade Financing Alternatives

1) Which of the following is NOT a factor in the discounting of a securitized export receivable?
A) The cost of credit insurance.
B) The historic collection risk of the importer.
C) The historic collection risk of the exporter.
D) The size of the financing and service fees.
Answer: B
Diff: 1
Topic: 19.6 Trade Financing Alternatives
Skill: Recognition

2) An exporter who insists on cash or a letter of credit for foreign shipments is likely to lose orders to
competitors from other countries that provide more favorable credit terms.
Answer: TRUE
Diff: 1
Topic: 19.6 Trade Financing Alternatives
Skill: Conceptual

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3) The Export-Import Bank is an independent agency of the U.S. government established in 1934 to
A) ship money abroad.
B) import agricultural products during the recession.
C) facilitate and stimulate foreign trade of the United States.
D) none of the above.
Answer: C
Diff: 1
Topic: 19.6 Trade Financing Alternatives
Skill: Recognition

4) In the United States, the Foreign Credit Insurance Corporation

A) is a subsidiary of the Export-Import Bank.
B) provides letters of credit for U.S. importers.
C) provides letters of credit for U.S. exporters.
D) provides policies that protect U.S. exporters against default by foreign importers.
Answer: D
Diff: 1
Topic: 19.6 Trade Financing Alternatives
Skill: Recognition

Instruction 19.1:
Use the information to answer the following question(s).

Jackson Automotive Inc. of California agrees to sell specialized automotive parts to Hidatsi of Korea.
Because the two companies have never done business with each other, Jackson requires a banker's
acceptance as payment for the $1,000,000 order. The banker's acceptance carries a 1.4% commission per
annum and payment is to be received in 6 months. If Jackson Inc. chooses to discount or sell the bankers
acceptance to its bank, the discount rate is 1.00% per annum.

5) Refer to Instruction 19.1. What is the size of the commission Jackson Automotive will pay the bank
for the banker's acceptance?
A) $7,000
B) $5,000
C) $12,000
D) $14,000
Answer: A
Diff: 2
Topic: 19.6 Trade Financing Alternatives
Skill: Analytical

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6) Refer to Instruction 19.1. What is the size of the discount (not including the commission fee) Jackson
must take for receiving the proceeds of the sale today rather than waiting for six months?
A) $7,000
B) $5,000
C) $12,000
D) $14.000
Answer: B
Diff: 2
Topic: 19.6 Trade Financing Alternatives
Skill: Analytical

7) Refer to Instruction 19.1. What is the total Jackson Automotive can expect to receive if the firm takes
payment today?
A) $993,000
B) $995,000
C) $988,000
D) $996,000
Answer: C
Diff: 2
Topic: 19.6 Trade Financing Alternatives
Skill: Analytical

8) Refer to Instruction 19.1. ________ is an unsecured promissory note.

A) A banker's acceptance
B) An overdraft
C) A securitized loan
D) Commercial paper
Answer: D
Diff: 2
Topic: 19.6 Trade Financing Alternatives
Skill: Recognition

9) Custom Granite Inc. has a Canadian receivables contract for $200,000 due in 270 days. The firm has
been approached by a factoring firm that offers to purchase the receivables at a 12% per annum discount
plus a 1% charge for a nonrecourse clause. What is the annualized percentage all-in-cost of this
factoring alternative?
A) 14.82%
B) 13.00%
C) 12.00%
D) 9.09%
Answer: A
Diff: 2
Topic: 19.6 Trade Financing Alternatives
Skill: Analytical

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19.7 Forfaiting: Medium- and Long-Term Financing

1) ________ is a French term meaning to forfeit or surrender a right.

A) Parfait
B) Forfait
C) Mon Dieu
D) Je ne sais pas
Answer: B
Diff: 1
Topic: 19.7 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition

2) In a typical forfaiting agreement the importer and exporter agree between themselves on a series of
imports to be paid for over a period of time, typically three to five years.
Answer: TRUE
Diff: 1
Topic: 19.7 Forfaiting: Medium- and Long-Term Financing
Skill: Recognition

3) The essence of forfaiting is the non-recourse sale by an exporter of bank-guaranteed promissory

notes, bills of exchange, or similar documents received from an importer in another country.
Answer: TRUE
Diff: 1
Topic: 19.7 Forfaiting: Medium- and Long-Term Financing
Skill: Conceptual

Essay Questions

19.1 The Trade Relationship

1) The nature of the relationship between the exporter and the importer is critical to understanding the
methods for import-export financing utilized in industry. Provide an overview of the three categories of
relationships: unaffiliated unknown, unaffiliated known, and affiliated.
Answer: A foreign importer with which a firm has not previously conducted business would be
considered unaffiliated unknown. In this case, the two parties would need to enter into a detailed sales
contract, outlining the specific responsibilities and expectations of the business agreement.

A foreign importer with which a firm has previously conducted business successfully would be
considered unaffiliated known. In this case, the two parties may still enter into a detailed sales contract,
but specific terms and shipments or provisions of services may be significantly looser in definition.

A foreign importer which is a subsidiary business unit of Trident, such as Trident Brazil, would be an
affiliated party (sometime referred to as intrafirm trade). Because both businesses are part of the same
MNE, the most common practice would be to conduct the trade transaction without a contract or
protection against nonpayment.
Diff: 3
Topic: 19.1 The Trade Relationship

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19.2 The Trade Dilemma

1) What is the trade dilemma and how is the dilemma generally solved?
Answer: International trade must work around a fundamental dilemma. Imagine an importer and an
exporter who would like to do business with one another. Because of the distance between the two, it is
not possible to simultaneously hand over goods with one hand and accept payment with the other. The
fundamental dilemma of being unwilling to trust a stranger in a foreign land is solved by using a highly
respected bank as intermediary.

The importer obtains the bank's promise to pay on its behalf, knowing that the exporter will trust the
bank.The bank's promise to pay is called a letter of credit. The exporter ships the merchandise to the
importer's country. Title to the merchandise is given to the bank on a document called an order bill of
lading. The exporter asks the bank to pay for the goods, and the bank does so. The document to request
payment is a sight draft. The bank, having paid for the goods, now passes title to the importer, whom the
bank trusts. At that time or later, depending on their agreement, the importer reimburses the bank.
Diff: 3
Topic: 19.2 The Trade Dilemma

19.3 Letter of Credit (L/C)

1) Explain what a letter of credit (L/C) is, who the principle parties are, what the principle advantage is,
and how the L/C facilitates international trade.
Answer: A letter of credit (L/C) is a bank's conditional promise to pay issued by a bank at the request of
an importer. The primary advantage of an L/C is the reduction in risk. This reduction in risk makes it
easier for the exporter to sell goods to the importer because it no longer need rely on the ability of the
importing firm to pay for the goods, but rather it can rely on the bank.

There are three primary parties involved with a letter of credit. Party number one is the exporter, who
makes a sale to the importer in exchange for the bank's L/C. Party number two is the importer who
receives the goods and promises to pay the bank. And third, the bank that contracts with the importer
and agrees to pay the exporter upon presentation of documents as specified in the L/C.

The advantage to an exporter is the increased likelihood of receiving payment because funds are due
from a known international commercial bank as opposed to a relatively unknown importer. Furthermore,
an exporter with a good reputation for delivery may be able to sell the L/C at a discount in the secondary
market prior to shipping and speed up cash flow.

The importer benefits because it doesn't need to pay for goods purchased until they actually reach port.
The bank benefits from the fees they charge.
Diff: 3
Topic: 19.3 Letter of Credit (L/C)

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19.4 Draft

1) What is a banker's acceptance? How are they initiated? Why are they desirable for the exporter?
Answer: A draft, or bill of exchange, is a written order from the exporter telling the importer when and
how much to pay. When properly contracted, a draft can become a negotiable instrument and trade in
the secondary market. If the draft provides a specific payment date and is presented to the importer's
bank, it becomes a banker's acceptance (BA) and the bank makes an unconditional promise to make
payment upon maturity. A BA may sell in the secondary market like any other marketable security and
the holder need not wait until maturity to liquidate. Thus, BAs facilitate trade by reducing risk and
potentially speeding cash flows to the exporter.
Diff: 3
Topic: 19.4 Draft

19.5 Government Programs to Help Finance Exports

1) What is the Import-Export Bank and how can it aid in export financing?
Answer: The Export-Import Bank (also called Eximbank) is another independent agency of the U.S.
government, established in 1934 to stimulate and facilitate the foreign trade of the United States. In
1945, the Eximbank was re-chartered "to aid in financing and to facilitate exports and imports and the
exchange of commodities between the United States and any foreign country or the agencies or nationals
thereof."

The Eximbank facilitates the financing of U.S. exports through various loan guarantee and insurance
programs.The Eximbank guarantees repayment of medium-term (181 days to five years) and long-term
(five years to ten years) export loans extended by U.S. banks to foreign borrowers. The Eximbank's
medium- and long-term, direct-lending operation is based on participation with private sources of funds.
Essentially, the Eximbank lends dollars to borrowers outside the United States for the purchase of U.S.
goods and services. Proceeds of such loans are paid to U.S. suppliers.The loans themselves are repaid
with interest in dollars to the Eximbank.The Eximbank requires private participation in these direct
loans in order to: 1) ensure that it complements rather than competes with private sources of export
financing; 2) spread its resources more broadly; and 3) ensure that private financial institutions will
continue to provide export credit.

The Eximbank also guarantees lease transactions, finances the costs involved in the preparation by U.S.
firms of engineering, planning, and feasibility studies for non-U.S. clients on large capital projects; and
supplies counseling for exporters, banks, or others needing help in finding financing for U.S. goods.

Diff: 3
Topic: 19.5 Government Programs to Help Finance Exports

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19.6 Trade Financing Alternatives

1) Define and describe the process of factoring. When might this process be attractive to firms?
Answer: Specialized firms, known as factors, purchase receivables at a discount on either a non-
recourse or recourse basis. Non-recourse means that the factor assumes the credit, political, and foreign
exchange risk of the receivables it purchases. Recourse means that the factor can give back receivables
that are not collectable. Since the factor must bear the cost and risk of assessing the credit worth of each
receivable, the cost of factoring is usually quite high. It is more than borrowing at the prime rate plus
points.

The all-in cost of factoring non-recourse receivables is similar in structure to acceptances. The factor
charges a commission to cover the non-recourse risk, typically 1.5%––2.5%, plus interest deducted as a
discount from the initial proceeds. On the other hand, the firm selling the non-recourse receivables
avoids the cost of determining credit worth of its customers. It also does not have to show debt borrowed
to finance these receivables on its balance sheet. Furthermore, the firm avoids both foreign exchange
and political risk on these non-recourse receivables.
Diff: 3
Topic: 19.6 Trade Financing Alternatives

19.7 Forfaiting: Medium- and Long-Term Financing

1) Forfaiting is a complicated process. The author describes the procedure through a seven part process.
Please describe the forfaiting process.
Answer: Step 1: Agreement. Importer and exporter agree between themselves on a series of imports to
be paid for over a period of time, typically three to five years.
Step 2: Commitment. The forfaiter promises to finance the transaction at a fixed discount rate, with
payment to be made when the exporter delivers to the forfaiter the appropriate promissory notes or other
specified paper.
Step 3: Aval or Guarantee. The importer obligates itself to pay for its purchases by issuing a series of
promissory notes, usually maturing every six or twelve months, against progress on delivery or
completion of the project.
Step 4: Delivery of Notes. The now-endorsed promissory notes are delivered to the exporter.
Step 5: Discounting. The exporter endorses the notes "without recourse" and discounts them with the
forfaiter, receiving the agreed-upon proceeds.
Step 6: Investment. The forfaiting bank either holds the notes until full maturity as an investment
or endorses and rediscounts them in the international money market.
Step 7: Maturity. At maturity, the investor holding the notes presents them for collection to the
importer or to the importer's bank.The promise of the importer's bank is what gives the
documents their value.
Diff: 3
Topic: 19.7 Forfaiting: Medium- and Long-Term Financing

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