I.

Definition :

Bankers acceptances A bankers acceptance is an order to pay a specified amount of money to the bearer on a given date. The banker's acceptance specifies the amount of money, the date, and the person to which the payment is due. It is a promised future payment, or time draft, which is accepted and guaranteed by a bank and drawn on a deposit at the bank. After acceptance, the draft becomes an unconditional liability of the bank. II. Why it appeared Bankers acceptances have been in use since the twelfth century. However, they were not major money market securities until the volume of international trade ballooned in the 1960s. They are used to finance goods that have not yet been transferred from the seller to the buyer or when the buyer does not have a close relationship with and cannot obtain credit from an exporter. Its real purpose is to use the bank's credit to obtain funds For example, suppose that B wants to buy a bulldozer from A in Japan. A does not want to ship the bulldozer without being paid because A has never heard of B and realizes that it would be difficult to collect if payment were not forthcoming. Similarly, B is reluctant to send money to Japan before receiving the equipment. A bank can intervene in this standoff by issuing a bankers acceptance. III. Using a bankers acceptance

The transaction would begin with B obtaining a LC from its bank. A LC simply says that if B has not paid its obligation by a certain time, the bank will make payment. This particular LC will also authorize the exporter (A 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. B sends the order for the bulldozer, along with the LC, to A. When A receives these documents, it is willing to ship the equipment because the banks credit standing has been substituted for that of the actual buyer. Once the equipment has been shipped, A will present the LC and the shipping documents to its own bank in Japan. This bank will create the time draft authorized by the LC and send it to Bs bank. When Bs bank receives the time draft and the shipping documents, it will stamp the time draft accepted and return it to As bank. This accepted time draft is now a bankers acceptance. Because it is backed by the credit of a bank, it can be traded on the secondary market. Typically, the exporters 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 B deposits the funds in its bank to cover the amount of the bankers acceptance. When the bankers acceptance finally matures and is presented for payment, the issuing bank withdraws funds from Bs account to make payment. Of course, if for some reason B was unable to make the required deposit, its bank would pay the acceptance anyway and attempt to collect from B later. Let me summarize the steps for using bankers acceptances: 1. The importer requests its bank to send an irrevocable LC 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 exporters bank creates a time draft based on the LC and sends it along with proof of shipment to the importers bank. 4. The importers bank stamps the time draft accepted and sends the bankers acceptance back to the exporters bank so that the exporters bank can sell it on the secondary market to collect payment. 5. The importer deposits funds at its bank sufficient to cover the bankers acceptance when it matures. IV. Advantages As the bulldozer exampke demonstrates, bankers 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 : 1. The exporter is paid immediately. This is important when delivery times are long after shipment. 2. The exporter is shielded from foreign exchange risk because the local bank pays in domestic funds. 3. The exporter does not have to assess the creditworthiness of the importer because the importers bank guarantees payment. V. Liquidity or the secondary market The holder of the draft can sell (exchange) it for cash to any party willing to wait for the face value payment of the deposit on the maturity date. Acceptances are traded at a discount from face value on the secondary market. Banker's acceptances are very similar to T-bills and are often used in money market funds. Dealers in this market match up firms that want to discount a bankers acceptance (sell it for immediate payment) with companies wishing to invest in bankers acceptances. Interest rates on bankers acceptances are low because the risk of default is very low. Bank acceptances are in very high standing as safe and liquid investments. For example, no investor in bankers acceptances in the USA 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.