Iman Hojeije

Liz Igiraneza
Case Study #5

A letter of credit is an instrument from the bank which guarantees a buyer's payment to a seller.
It promises to pay the holder if the holder fulfills certain obligations. Obligations include payment
when the goods are shipped if certain criteria are met.

The advantages of LCs are:

a. Legally binding: All parties need to agree to cancel them
b. Offer clarity: Gives defined in an LC are specific and well- defined so the details of a
transaction are generally very transparent
c. Risk production: the exporter or payment to the seller is guaranteed payment providing
the terms of the LCA met
d. Allow safe trading LC: focus of international trade and allow companies to safely in
unfamiliar market with unfamiliar suppliers

If the buyer cannot pay due to the agreed contract through the letter of credit the bank will cover
the remaining price. In the event that the buyer is unable to make a payment on the purchase,
the bank will be required to cover the full or remaining amount of the purchase.

The letter of credit ensures that I am paid as a creditor, which mitigates the risk of not getting
paid by the buyer.

The different types of letter of credit are:

a. Irrevocable letter of credit - this can be amended or cancelled when all parties agree
b. Confirmed letter of credit - this adds security to the seller, if the issuing bank fails to pay
the seller, the seller’s bank pays
c. Deferred letter of credit - payment to the seller is delayed until an agreed certain of time
has elapsed

For the beneficiary to receive payment, they have to present documentation to prove completion
of their part of the obligation, these documents include invoice bills, bills of exchange and
government documents.

The documents you will encounter in trade finance as an international trade company are:
Documents are entrusted to a bank for delivery to a buyer only after the sellers collection
instructions are met. They include:
a. Commercial Invoice: a legal document between the supplier and the customer that
clearly describes' the sold goods, and the amount due on the customer
b. Bill of Lading: a detailed list of a shipment of goods in the form of a receipt given by the
carrier to the person consigning the goods.
 c. Bill of Exchange: a written order used primarily in international trade that binds one party
to pay a fixed sum of money to another party on demand or at a predetermined date.
These are necessary papers required for customs clearance and the collection of goods.

Challenges that some of the trade finance companies are experiencing are:
a. Inherent issue around trade-based money laundering
b. Dual use goods
c. Exchange rates
d. Over pricing by some countries- there is a price disparity between countries and the
world value.
e. Lack of financing from banks, leading them to get financing from non-banks that are
riskier
The major exposures of risk are:
a. Natural hazards
b. Payment risk- the risk of the buyer not paying the seller
c. Financial or Economic loss

Three risk-mitigation options would be:

a. Confirmed letters of credit: Take on the full risk of transactions
b. Export credit and receivables insurance: Obtain a wide range of insurance products
c. Bonds, guarantees and standby credits: Required when large tenders are published.