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International trade has flourished over the years due to the many
benefits it has offered to different countries across the globe.
International trade is the exchange of services, goods, and capital
among various countries and regions, without much hindrance. The
international trade accounts for a good part of a country’s gross
domestic product. It is also one of important sources of revenue for a
developing country.
With the help of modern production techniques, highly advanced transportation systems,
transnational corporations, outsourcing of manufacturing and services, and rapid
industrialization, the international trade system is growing and spreading very fast.

International trade among different countries is not a new a concept. History suggests that
in the past there where several instances of international trade. Traders used to transport
silk, and spices through the Silk Route in the 14th and 15th century. In the 1700s fast
sailing ships called Clippers, with special crew, used to transport tea from China, and spices
from Dutch East Indies to different European countries.

The economic, political, and social significance of international trade has been theorized in
the Industrial Age. The rise in the international trade is essential for the growth of
globalization. The restrictions to international trade would limit the nations to the services
and goods produced within its territories, and they would lose out on the valuable revenue
from the global trade.

The benefits of international trade have been the major drivers of growth for the last half of
the 20th century. Nations with strong international trade have become prosperous and have
the power to control the world economy. The global trade can become one of the major
contributors to the reduction of poverty.

David Ricardo, a classical economist, in his principle of comparative advantage explained

how trade can benefit all parties such as individuals, companies, and countries involved in
it, as long as goods are produced with different relative costs. The net benefits from such
activity are called gains from trade. This is one of the most important concepts in
international trade.

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Adam Smith, another classical economist, with the use of principle of absolute advantage
demonstrated that a country could benefit from trade, if it has the least absolute cost of
production of goods, i.e. per unit input yields a higher volume of output.

According to the principle of comparative advantage, benefits of trade are dependent on the
opportunity cost of production. The opportunity cost of production of goods is the amount of
production of one good reduced, to increase production of another good by one unit. A
country with no absolute advantage in any product, i.e. the country is not the most
competent producer for any goods, can still be benefited from focusing on export of goods
for which it has the least opportunity cost of production.

Benefits of International Trade can be reaped further, if there is a considerable decrease in

barriers to trade in agriculture and manufactured goods.

Some important benefits of International Trade

 Enhances the domestic competitiveness

 Takes advantage of international trade technology
 Increase sales and profits
 Extend sales potential of the existing products
 Maintain cost competitiveness in your domestic market
 Enhance potential for expansion of your business
 Gains a global market share
 Reduce dependence on existing markets
 Stabilize seasonal market fluctuations

Export Finance and Documentation.

 Introduction
 Air Waybill
 Bill of Lading
 Certificate of Origin
 Combined Transport Document
 Draft (or Bill of Exchange)

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 Insurance Policy (or Certificate)

 Packing List/Specification
 Inspection Certificate

Introduction

International market involves various types of trade documents that need to be produced
while making transactions. Each trade document is differ from other and present the various
aspects of the trade like description, quality, number, transportation medium, indemnity,
inspection and so on. So, it becomes important for the importers and exporters to make sure
that their documents support the guidelines as per international trade transactions. A small
mistake could prove costly for any of the parties.

For example, a trade document about the bill of lading is a proof that goods have been
shipped on board, while Inspection Certificate, certifies that the goods have been inspected
and meet quality standards. So, depending on these necessary documents, a seller can assure
a buyer that he has fulfilled his responsibility whilst the buyer is assured of his request being
carried out by the seller.

The following is a list of documents often used in international trade:

 Air Waybill
 Bill of Lading
 Certificate of Origin
 Combined Transport Document
 Draft (or Bill of Exchange)
 Insurance Policy (or Certificate)
 Packing List/Specification
 Inspection Certificate

Air Waybills

Air Waybills make sure that goods have been received for shipment by air. A typical air
waybill sample consists of of three originals and nine copies. The first original is for the
carrier and is signed by a export agent; the second original, the consignee's copy, is signed by
an export agent; the third original is signed by the carrier and is handed to the export agent
as a receipt for the goods.

Air Waybills serves as:

• Proof of receipt of the goods for shipment.

• An invoice for the freight.
• A certificate of insurance.
• A guide to airline staff for the handling, dispatch and delivery of the consignment.

The principal requirement for an air waybill are :

 The proper shipper and consignee must be mention.

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 The airport of departure and destination must be mention.

 The goods description must be consistent with that shown on other documents.
 Any weight, measure or shipping marks must agree with those shown on other
documents.
 It must be signed and dated by the actual carrier or by the named agent of a named
carrier.
 It must mention whether freight has been paid or will be paid at the destination point.

Bill of Lading (B/L)

Bill of Lading is a document given by the shipping agency for the goods shipped for
transportation form one destination to another and is signed by the representatives of the
carrying vessel.

Bill of landing is issued in the set of two, three or more. The number in the set will be
indicated on each bill of lading and all must be accounted for. This is done due to the safety
reasons which ensure that the document never comes into the hands of an unauthorised
person. Only one original is sufficient to take possession of goods at port of discharge so, a
bank which finances a trade transaction will need to control the complete set. The bill of
lading must be signed by the shipping company or its agent, and must show how many signed
originals were issued.

It will indicate whether cost of freight/ carriage has been paid or not :

"Freight Prepaid" : Paid by shipper

"Freight collect" : To be paid by the buyer at the port of discharge

The bill of lading also forms the contract of carriage.

To be acceptable to the buyer, the B/L should :

 Carry an "On Board" notation to showing the actual date of shipment, (Sometimes
however, the "on board" wording is in small print at the bottom of the B/L, in which
cases there is no need for a dated "on board" notation to be shown separately with
date and signature.)
 Be "clean" have no notation by the shipping company to the effect that goods/
packaging are damaged.

The main parties involve in a bill of lading are:

 Shipper
o The person who send the goods.
 Consignee
o The person who take delivery of the goods.
 Notify Party
o The person, usually the importer, to whom the shipping company or its agent
gives notice of arrival of the goods.
 Carrier
o The person or company who has concluded a contract with the shipper for
conveyance of goods
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The bill of lading must meet all the requirements of the credit as well as complying with UCP
500. These are as follows :

 The correct shipper, consignee and notifying party must be shown.

 The carrying vessel and ports of the loading and discharge must be stated.
 The place of receipt and place of delivery must be stated, if different from port of
loading or port of discharge.
 The goods description must be consistent with that shown on other documents.
 Any weight or measures must agree with those shown on other documents.
 Shipping marks and numbers and /or container number must agree with those shown
on other documents.
 It must state whether freight has been paid or is payable at destination.
 It must be dated on or before the latest date for shipment specified in the credit.
 It must state the actual name of the carrier or be signed as agent for a named carrier.

Certificate of Origin

The Certificate of Origin is required by the custom authority of the importing country for the
purpose of imposing import duty. It is usually issued by the Chamber of Commerce and
contains information like seal of the chamber, details of the good to be transported and so
on.

The certificate must provide that the information required by the credit and be consistent
with all other document, It would normally include :

 The name of the company and address as exporter.

 The name of the importer.
 Package numbers, shipping marks and description of goods to agree with that on other
documents.
 Any weight or measurements must agree with those shown on other documents.
 It should be signed and stamped by the Chamber of Commerce.

Combined Transport Document

Combined Transport Document is also known as Multimodal Transport Document, and is used
when goods are transported using more than one mode of transportation. In the case of
multimodal transport document, the contract of carriage is meant for a combined transport
from the place of shipping to the place of delivery. It also evidence receipt of goods but it
does not evidence on board shipment, if it complies with ICC 500, Art. 26(a). The liability of
the combined transport operator starts from the place of shipment and ends at the place of
delivery. This documents need to be signed with appropriate number of originals in the full
set and proper evidence which indicates that transport charges have been paid or will be paid
at destination port.

Multimodal transport document would normally show :

 That the consignee and notify parties are as the credit.

 The place goods are received, or taken in charges, and place of final destination.
 Whether freight is prepaid or to be collected.

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 The date of dispatch or taking in charge, and the "On Board" notation, if any must be
dated and signed.
 Total number of originals.
 Signature of the carrier, multimodal transport operator or their agents.

Commercial Invoice

Commercial Invoice document is provided by the seller to the buyer. Also known as export
invoice or import invoice, commercial invoice is finally used by the custom authorities of the
importer's country to evaluate the good for the purpose of taxation.

The invoice must :

 Be issued by the beneficiary named in the credit (the seller).

 Be address to the applicant of the credit (the buyer).
 Be signed by the beneficiary (if required).
 Include the description of the goods exactly as detailed in the credit.
 Be issued in the stated number of originals (which must be marked "Original) and
copies.
 Include the price and unit prices if appropriate.
 State the price amount payable which must not exceed that stated in the credit
 include the shipping terms.

Bill of Exchange

A Bill of Exchange is a special type of written document under which an exporter ask importer
a certain amount of money in future and the importer also agrees to pay the importer that
amount of money on or before the future date. This document has special importance in
wholesale trade where large amount of money involved.

Following persons are involved in a bill of exchange:

Drawer: The person who writes or prepares the bill.
Drawee: The person who pays the bill.
Payee: The person to whom the payment is to be made.
Holder of the Bill: The person who is in possession of the bill.

On the basis of the due date there are two types of bill of exchange:

 Bill of Exchange after Date: In this case the due date is counted from the date of
drawing and is also called bill after date.
 Bill of Exchange after Sight: In this case the due date is counted from the date of
acceptance of the bill and is also called bill of exchange after sight.

Insurance Certificate

Also known as Insurance Policy, it certifies that goods transported have been insured under an
open policy and is not actionable with little details about the risk covered.

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It is necessary that the date on which the insurance becomes effective is same or earlier than
the date of issuance of the transport documents.

Also, if submitted under a LC, the insured amount must be in the same currency as the credit
and usually for the bill amount plus 10 per cent.

The requirements for completion of an insurance policy are as follow :

 The name of the party in the favor which the documents has been issued.
 The name of the vessel or flight details.
 The place from where insurance is to commerce typically the sellers warehouse or the
port of loading and the place where insurance cases usually the buyer's warehouse or
the port of destination.
 Insurance value that specified in the credit.
 Marks and numbers to agree with those on other documents.
 The description of the goods, which must be consistent with that in the credit and on
the invoice.
 The name and address of the claims settling agent together with the place where
claims are payable.
 Countersigned where necessary.
 Date of issue to be no later than the date of transport documents unless cover is
shown to be effective prior to that date.

Packing List

Also known as packing specification, it contain details about the packing materials used in the
shipping of goods. It also include details like measurement and weight of goods.

The packing List must :

 Have a description of the goods ("A") consistent with the other documents.
 Have details of shipping marks ("B") and numbers consistent with other documents

Inspection Certificate

Certificate of Inspection is a document prepared on the request of seller when he wants the
consignment to be checked by a third party at the port of shipment before the goods are
sealed for final transportation.

In this process seller submit a valid Inspection Certificate along with the other trade
documents like invoice, packing list, shipping bill, bill of lading etc to the bank for
negotiation.

On demand, inspection can be done by various world renowned inspection agencies on

nominal charges.

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Introduction to International Finance — Presentation Transcript

 1. International Trade & Working Capital Management Reading:

Chapters 20 , 21 (685-690) and 2 2

 2. Lecture Outline International Trade Trade Dilemma Letter of Credit,

Draft and Countertrade Working Capital Management Cash, Accounts
Receivable, Inventory Short-Term Financing Managing the MN E
Financial System

 3. International Trade Most MN E s are heavily involved in international

trade (exporting and importing), so it is important to know how it works
and the risks involved.

 4. The nature of the relationship between the exporter and the importer
is critical to understanding the methods for import-export financing
utilized in industry. There are three categories of relationships (see next
exhibit): Unaffiliated unknown Unaffiliated known Affiliated (sometimes
referred to as intra-firm trade ) The composition of global trade has
changed dramatically over the past few decades, moving from
transactions between unaffiliated parties to affiliated transactions.
Trade Relationships

 5. Trade Relationships

 6. Trade Dilemma

 7. The fundamental dilemma of being unwilling to trust a stranger in a

foreign land is solved by using a highly respected bank as an
intermediary. The following exhibit is a simplified view involving a letter
of credit (a bank’s promise to pay) on behalf of the importer. Two other
significant documents are a bill of lading and a sight draft . Trade
Dilemma

 8. Solving the Trade Dilemma

 9. This system has been developed and modified over centuries to

protect both the importer and exporter from: The risk of noncompletion
Foreign exchange risk And, to provide a means of financing Solving the
Trade Dilemma

 10. A letter of credit (L/C) is a bank’s conditional promise to pay issued

by a bank at the request of an importer, in which the bank promises to
pay an exporter upon presentation of documents specified in the L/C.

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An L/C reduces the risk of non-completion because the bank agrees to

pay against documents rather than actual merchandise. Letter of Credit

 11. Letters of credit are also classified as: Irrevocable versus revocable
Confirmed versus unconfirmed The primary advantage of an L/C is that
it reduces risk – the exporter can sell against a bank’s promise to pay
rather than against the promise of a commercial firm. The major
advantage of an L/C to an importer is that the importer need not pay
out funds until the documents have arrived at the bank that issued the
L/C and after all conditions stated in the credit have been fulfilled.
Letter of Credit

 12. Letter of Credit

 13. A draft , sometimes called a bill of exchange (B/E), is the instrument

normally used in international commerce to effect payment. A draft is
simply an order written by an exporter (seller) instructing and importer
(buyer) or its agent to pay a specified amount of money at a specified
time. The person or business initiating the draft is known as the maker ,
drawer or originator . Normally this is the exporter who sells and ships
the merchandise. The party to whom the draft is addressed is the
drawee . Draft

 14. If properly drawn, drafts can become negotiable instruments . As

such, they provide a convenient instrument for financing the
international movement of merchandise (freely bought and sold). To
become a negotiable instrument, a draft must conform to the following
four requirements: It must be in writing and signed by the maker or
drawer. It must contain an unconditional promise or order to pay a
definite sum of money. It must be payable on demand or at a fixed or
determinable future date. It must be payable to order or to bearer.
There are time drafts and sight drafts. Draft

 15. The third key document for financing international trade is the bill of
lading or B/L. The bill of lading is issued to the exporter by a common
carrier transporting the merchandise. It serves three purposes: a
receipt, a contract and a document of title. Bills of lading are either
straight or to order. Bill of Lading

 16. A trade transaction could conceivably be handled in many ways.

The transaction that would best illustrate the interactions of the various
documents would be an export financed under a documentary
commercial letter of credit, requiring an order bill of lading, with the
exporter collecting via a time draft accepted by the importer’s bank. The
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following exhibit illustrates such a transaction. Typical Trade

Transaction

 17.

 18. In order to finance international trade receivables, firms use the

same financing instruments as they use for domestic trade receivables,
plus a few specialized instruments that are only available for financing
international trade. There are short-term financing instruments and
longer-term instruments in addition to the use of various types of barter
to substitute for these instruments. Trade Financing Alternatives

 19. Some of the shorter term financing instruments include: Bankers

Acceptances Trade Acceptances Factoring Securitization Bank Credit
Lines Covered by Export Credit Insurance Commercial Paper Forfaiting
is a longer term financing instrument. Trade Financing Alternatives

 20. The word countertrade refers to a variety of international trade

arrangements in which goods and services are exported by a
manufacturer with compensation linked to that manufacturer accepting
imports of other goods and services. In other words, an export sale is
tied by contract to an import. The countertrade may take place at the
same time as the original export, in which case credit is not an issue; or
the countertrade may take place later, in which case financing becomes
important. Countertrade

 21.

 22. Governments of most export-oriented industrialized countries have

special financial institutions that provide some form of subsidized credit
to their own national exporters. These export finance institutions offer
terms that are better than those generally available from the
competitive private sector. Thus domestic taxpayers are subsidizing
lower financial costs for foreign buyers in order to create employment
and maintain a technological edge. The most important institutions
usually offer export credit insurance and a government-supported bank
for export financing. Government Trade Promotion

 23. Working capital management in a multinational enterprise requires

managing current assets (cash balances, accounts receivable and
inventory) and current liabilities (accounts payable and short-term debt)
when faced with political, foreign exchange, tax and liquidity
constraints. The overall goal is to reduce funds tied up in working
capital while simultaneously providing sufficient funding and liquidity for

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the conduct of global business. Working capital management should

enhance return on assets and return on equity and should also improve
efficiency ratios and other performance measures. Working Capital
Management

 24. International cash management is the set of activities determining

the levels of cash balances held throughout the MNE ( cash
management ) and the facilitation of its movement cross-border (
settlements and processing ). These activities are typically handled by
the international treasury of the MNE. Cash balances, including
marketable securities, are held partly to enable normal day-to-day cash
disbursements and partly to protect against unanticipated variations
from budgeted cash flows. These two motives are called the
transaction motive and the precautionary motive . International Cash
Management

 25. Efficient cash management aims to reduce cash tied up

unnecessarily in the system, without diminishing profit or increasing
risk, so as to increase the rate of return on invested assets. Over time a
number of techniques and services have evolved that simplify and
reduce the costs of making cross-border payments. Four such
techniques include: Wire transfers Cash pooling Payment netting
Electronic fund transfers International Cash Management

 26. Payment Netting

 27. Payment Netting

 28. Accounts Receivable Management Trade credit is provided to

customers on the expectation that it increases overall profits by:
Expanding sales volume Retaining customers Companies must keep a
close eye on who they are extended, why they are doing it and in which
currency. One way to better manage overseas receivables is to adjust
staff sales bonuses for the interest and currency costs of credit sales.

 29. Inventory Management MNCs tend to have difficulties in inventory

management due to long transit times and lengthy customs
procedures. Overseas production can lead to higher inventory carrying
costs. Must weigh up benefits and costs of inventory stockpiling. Could
adjust affiliates profit margins to reflect added stockpiling costs.

 30. Inventory Management Example: Cypress Semiconductor decided

not to manufacture their circuits overseas. By producing overseas they
can reduce labour costs by $0.032 per chip. BUT, offshore production

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incurs extra shipping and customs costs of $0.025 per chip. AND, ties
up capital in inventory for extra 5 weeks: Capital cost = cost of funds x
extra time x cost of part = 0.20 x 5/52 x $8 = $0.154

 31. Short-Term Financing Take advantage of discount on Accounts

Payable? 2/10 net 60 – effective cost? Three principal short-term
financing options: Internal financing – borrowing from parent company
or other affiliates. Local currency loans – overdrafts, line of credit,
discounting (commercial paper) and term loans. Euro market
loans/issues – Euronotes and Euro-CP.

 32. Managing the MNE Financial System A firm operating globally

faces a variety of political, tax, foreign exchange and liquidity
considerations that limit its ability to move funds easily and without cost
from one country or currency to another. Political constraints can block
the transfer of funds either overtly or covertly. Tax constraints arise
because of the complex and possibly contradictory tax structures of
various national governments through whose jurisdictions funds might
pass. Foreign exchange transaction costs are incurred when one
currency is exchanged for another. Liquidity needs are often driven by
individual locations (difficult to conduct worldwide cash handling).

 33. Managing the MNE Financial System However, MN E s have

developed the following techniques, which overcome many of these
problems and help to maximize global profits : Unbundling funds
Transfer pricing Reinvoicing centers Internal loans

 34. Multinational firms often unbundle their transfer of funds into

separate flows for specific purposes. Host countries are then more
likely to perceive that a portion of what might otherwise be called
remittance of profits constitutes and essential purchase of specific
benefits that command worldwide values and benefit the host country.
Unbundling allows a multinational firm to recover funds from
subsidiaries without piquing host country sensitivities over large
dividend drains. Unbundling Funds

 35. Unbundling Funds

 36. Transfer Pricing Pricing internally traded goods of the firm for the
purpose of moving profits to a more tax-friendly location. This can
reduce taxes, tariffs and circumvent exchange controls. Example :
Suppose that affiliate A produces 100,000 circuit boards for $10 apiece
and sells them to affiliate B. Affiliate B, in turn, sells these boards for
$22 apiece to an unrelated customer. Pretax profit for the consolidated
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company is $1 million regardless of the price at which the goods are

transferred for A to B.

 37. Transfer Pricing - Example (internal unit price = $1 5 ): A B A+B

Revenue 1,500 2,200 2,200 COGS -1,000 -1,500 -1,000 Gross Profits
500 700 1,200 Expenses -100 -100 -200 Income b/t 400 600 1,000
Taxes (30/50) -120 -300 -420 Net Income 280 300 580

 38. Transfer Pricing - Example HIGH MARK-UP POLICY (unit price =

$18): A B A+B Revenue 1,800 2,200 2,200 COGS -1,000 -1,800 -1,000
Gross Profits 800 400 1,200 Expenses -100 -100 -200 Income b/t 700
300 1,000 Taxes (30/50) -210 -150 -360 Net Income 490 150 640

 39. Transfer Pricing In effect: Profits are shifted from a higher to a lower
tax jurisdiction. Basic rules: If t A > t B then set the transfer price and
the mark-up policy as LOW as possible. If t A < t B then set the transfer
price and the mark-up policy as HIGH as possible.

 40. Methods of Determining Transfer Prices Tax Office regulations

provide three methods to establish arm’s length prices: Comparable
uncontrolled prices Resale prices Cost-plus calculations In some
cases, combinations of these three methods are used. Transfer Pricing

 41. Reinvoicing Centers Reinvoicing centers can help coordinate

transfer pricing policy. They are set up in low-tax countries. Goods
travel directly from buyer to seller, but ownership passes through the
reinvoicing center. Advantages: Easier control on currency exposure
Flexibility in invoicing currency Disadvantages: Increased costs
Suspicion of tax evasion by local governments

 42. Internal Loans Internal loans add value to the MN E if credit

rationing, currency controls or differences in tax rates exist. Three main
types: Direct loans – from parent to affiliate. Back-to-back loans –
deposit by parent is lent to affiliate through a bank. Parallel loans – like
a loan swap between two MN E s and their affiliates.

 43. Remember… All of these internal funds flow mechanisms are

designed so that the MNE wins at the expense of other parties –
usually governments. Therefore, it is imperative that MNEs do this as
quietly and subtly as possible.

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