Secondary Market for Banker's Acceptances

Date: 2015-10-07; view: 549.

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.

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.