Chapter 8: DRAFTS AND ACCEPTANCES

CHAPTER 8

Drafts and Acceptances

IN DOCUMENTARY TRANSACTIONS sellers make a written demand upon either a bank or the buyer to pay for the shipment of goods. This demand accompanies the documentation package the seller presents to the bank. Such a formal written demand for payment is called a “draft.”

DRAFTS The formal definition of draft is: An unconditional order in writing, signed by a person (drawer) such as a buyer, and addressed to another person (drawee), typically a bank, ordering the drawee to pay a stated sum of money to yet another person (payee), often the seller, on demand or at a fixed or determinable future time.

The most common versions of drafts are: (1) Sight drafts which are payable when presented, and (2) Time drafts (also called usance drafts) which are payable at a future fixed (specific) date or determinable (e.g., 30, 60, 90 days) date.

ACCEPTANCES An acceptance is a time draft that has been accepted and signed by the drawee (the buyer or the bank) for payment at maturity. If a time draft is accepted by a buyer of merchandise, it is called a TRADE ACCEPTANCE . If a time draft is accepted by a bank it is called a BANKERS’ ACCEPTANCE . In most cases, obviously, a draft accepted by a bank enjoys higher credit standing than a draft accepted by a company or individual, since a bank is presumed to meet its obligation at maturity, and a company or individual in a foreign country may not as readily comply with its obligation.

HOLDING OR DISCOUNTING ACCEPTANCES In documentary transactions, the seller has two options, once the seller’s time draft is accepted. The seller may either hold it until maturity and collect full face value, or discount the draft, most likely with the accepting bank, and take the net value in cash immediately. In these ways, trade and bankers’ acceptances often represent the easiest, least expensive way for a seller to provide credit to a buyer, while enjoying the security provided by the documentary transaction.

FINANCING TRANSACTIONS USING ACCEPTANCES Thus, foreign buyers may indicate that they wish to provide a time documentary credit (rather than a sight documentary credit) but agree either to allow the seller to up the sales price slightly so as to offset the acceptance commission and discount costs or to absorb the acceptance commission and discount charges the bank will apply when discounting the draft at the request of the seller. In either case, the buyer and the buyer’s bank will absorb the charges involved, and the seller will receive the full contract sales amount. Since the charges are usually lower than conventional financing charges, the buyer is still better off than if financing had been obtained through a bank loan.

SAMPLE DRAFT AND ACCEPTANCE

3

1 Place/Date Basle, 10th October 19..

120 days' sight sole

Swiss Bank Corporation, Basle

US Dollars twentythreethousandfourhundred ------------------------

26784 15th September 19..

Universal Bank Inc., New York Universal Bank Inc. Park Street New York, N.Y. 10005 MUELLER AG BASEL

2

US$ 23'400.--

4 At please pay against this BILL of EXCHANGE ( being unpaid)

5 to the order of the amount of

2

6

7 Drawn under L/C No. dated

of

8

3

5

2

6

7 1 2

At please pay against this to the order of the amount of Value

Basle , 10th October 19.. US$ 23'400.-44 120 days' sight sole ourselves US Dollars twentythreethousandfourhundred -----------------------in goods. Drawn under documentary credit No 26784 of Universal MUELLER AG BASEL 9

M New York Trading Co. 1, Wall Street New York, N.Y. 10048 New York

MUELLER AG BASEL

No

Payable

1 2 3 4 5 Place drawn and date Currency and amount in numbers and words Validity period Number of originals (sole or first/second) If issued to own order: endorsement required 6 7 8 9

8

Reference to credit Drawee Drawer (handwritten signature) Endorsement

“CLEAN ” ACCEPTANCES A “clean” acceptance is one that does not have any notations attached that would compromise its value. In a trade acceptance the customer promises to pay the bank the full amount of the draft no later than the date of maturity, or upon demand of the bank. The accepted draft, when discounted, becomes a negotiable instrument that can be sold in the acceptance market, which is an over-the-counter market of brokers, dealers, and banks. Bankers acceptances are generally short-term, that is up to 180 days. Bankers’ acceptances become money market instruments once they are accepted by a major bank, which means that the bank has undertaken to honor this short-term note at its maturity. Because of this characteristic, bankers’ acceptances often result in a lower financing costs. The difference can range from 1 to 3 percent depending on the transaction and the bank involved. Thus, they are important sources of financing.