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BANKER'S ACCEPTANCE

Using a Banker's Acceptance.Banker's acceptances are used to finance goods that have not yet been transferred from the seller to the buyer. For example, suppose that Builtwell Construction Company wants to buy a bulldozer from Komatsu in Japan. Komatsu does not want to ship the bulldozer without being paid because Komatsu has never heard of Builtwell and realizes that it would be difficult to collect if payment were not forthcoming. Similarly, Builtwell is reluctant to send money to Japan before receiving the equipment. A bank can intervene in this standoff by issuing a banker's acceptance.

The transaction would begin with Builtwell obtaining a letter of credit from its bank. A letter of credit simply says that if Builtwell has not paid its obligation by a certain time, the bank will make payment. This particular letter of credit will also authorize the exporter (Komatsu or its bank) to draw a time draft for the amount of the sale. A time draft is like a postdated check: It can be cashed only after a certain date. Builtwell sends the order for the bulldozer, along with the letter of credit, to Komatsu.

When Komatsu receives these documents, it is willing to ship the equipment because the bank's credit standing has been substituted for that of the actual buyer. Once the equipment has been shipped, Komatsu will present the letter of credit and the shipping documents to its own bank in Japan. This bank will create the time draft authorized by the letter of credit and send it to Builtwell's bank. When Builtwell's bank receives the time draft and the shipping documents, it will stamp the time draft "accepted" and return it to Komatsu's bank. This accepted time draft is now a banker's acceptance. Because it is backed by the credit of a bank, it can be traded on the secondary market. Typically, the exporter's bank will sell it so that the exporter can receive funds before the maturity date. It will be sold at a discount so that the buyer can earn a fair return for holding it until its maturity date. The transaction is completed when Builtwell deposits the funds in its bank to cover the amount of the time draft (now a banker's acceptance). When the banker's acceptance finally matures and is presented for payment, the issuing bank withdraws funds from Builtwell's account to make payment. Of course, if for some reason Builtwell was unable to make the required deposit, its bank would pay the acceptance anyway and attempt to collect from Builtwell later.

Let us summarize the steps for using banker's acceptances.

1. The importer requests its bank to send an irrevocable letter of credit to the exporter.

2. The exporter receives the letter, ships the goods, and is paid by presenting to its bank the letter along with proof that the merchandise was shipped.

3. The exporter's bank creates a time draft based on the letter of credit and sends it along with proof of shipment to the importer's bank.

4. The importer's bank stamps the time draft "accepted" and sends the banker's acceptance back to the exporter's bank so that the exporter's bank can sell it on the secondary market to collect payment.

5. The importer deposits funds at its bank sufficient to cover the banker's acceptance when it matures.

Secondary Market for Banker's Acceptances

Because banker's acceptances are payable to the bearer, they can be bought and sold until they mature. They are sold on a discounted basis like commercial paper and T-bills. Dealers in this market match up firms that want to discount a banker's acceptance (sell it for immediate payment) with companies wishing to invest in banker's acceptances.

Interest rates on banker's acceptances are low because the risk of default is very low. For example, no investor in banker's acceptances in the United States has suffered a loss of principal in more than 60 years. The reason is that only large money center banks are involved in this market.

Advantages of Banker's Acceptances. As the bulldozer example demonstrates, banker's acceptances are crucial to international trade. Without them, many transactions simply would not occur because the parties would not feel properly protected from losses. There are other advantages as well:

· The exporter is paid immediately. This is important when delivery times are long after shipment.

· The exporter is shielded from foreign exchange risk because the local bank pays in domestic funds.

· The exporter does not have to assess the creditworthiness of the importer because the importer's bank guarantees payment.

TERMS FOR TEXT B

A bearer is the owner of a security or other instrument. One may bear any type of security. While technically a bearer is identical to a holder, the term "bearer" implies one who holds a security with no ownership information, automatically making the bearer the presumed owner.

A deep marketis one with many different buyers and sellers.

A discount loan is a loan where all the interest on it is paid at once. That is, the interest is deducted from the amount the borrower receives at the beginning of the loan.

A liquid marketis one in which securities can be bought and sold quickly and with low transaction costs.

Book entry is a certificate of ownership in a security that is maintained electronically. Rather than printing paper certificates, issuers of securities sometimes rely upon book-entries to reduce the risk of theft or destruction of the certificate.

Collateralis property or other assets that a borrower offers a lender to secure a loan.

Direct placement is selling a new issue not by offering it for sale publicly, but by placing it with one of several institutional investors.

Eurodollars -United States dollar held as Eurocurrency.

Federal funds are non-interest bearing deposits are lent out at the Fed funds rate to other banks unable to meet overnight reserve requirements. Funds deposited to regional Federal Reserve Banks by commercial banks, including funds in excess of reserve requirements.

Interest is the price paid for borrowing money. It is expressed as a percentage rate over a period of time and reflects the rate of exchange of present consumption for future consumption.

London interbank bid rate, (LIBID) is the average interest rate which major London banks borrow Eurocurrency deposits from other banks. LIBID is calculated through a survey of London banks to determine the interest rate which they are willing to borrow large Eurocurrency deposits.

London interbank offer rate, (LIBOR) is an interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.

Principal - 1.The amount borrowed or the amount still owed on a loan, separate from interest. 2. The original amount invested, separate from earnings. 3. The face value of a bond.4. The owner of a private company. 5. The main party to a transaction, acting as either a buyer or seller for his/her own account and risk.

Reserve requirement is a central bank requirement that stipulates the minimum amount of reserves each bank must hold as a proportion of customer deposits and notes.

WEB EXERCISES

The Money Markets

Up-to-date interest rates are available from the Federal Reserve at http://www.federalreserve. goy/releases. Locate the current rate on the following securities:

a. Prime rate

b. Federal funds

c. Commercial paper (financial)

d. Certificates of deposit

e. Discount rate

f. One-month Eurodollar deposits

table 1SAMPLE MONEY MARKET RATES, DECEMBER 15, 2004

Date: 2015-12-24; view: 934