Chapter 20: Trade Finance Instruments
Chapter 20 Introduction
Learning Objectives
After reading this chapter, you should be able to
- Identify and describe the various types of trade finance instruments.
- Describe the open account and advance payment methods of payment.
- Discuss the documentary collection method of payment, including bills of exchange and endorsement.
- Discuss the documentary credit method of payment including letters of credit.
- Describe the factoring and forfaiting methods of payment.
Think About It!
Video: Methods of Payment
Before reading this chapter, watch this video outlining the methods of payment used in international trade.
Source: International Trade Administration, (2022, February 10). Methods of payment. [Video]. YouTube. https://www.youtube.com/watch?v=g71-qrmmWXU
Test Yourself
Introduction
One of the important decisions organizations make when they decide to trade is payment terms. How to pay is one major decision made by trade organizations and is supported by trade finance instruments, also called methods of payment. Four methods of payment are commonly used: open account, advance payment, documentary collection, and documentary credit.
The first two methods are used when trade parties have established relationships, trust one another and there are no/low country or political risks. The other two methods are used where exporters and importers cannot trust one another. The reasons could be that they are working together for the first time or that there are high levels of country/political risks involved in exporting or importing countries. To establish trust, banks intervene and facilitate the movement of payments and documents.
There are some other innovative methods of payment like factoring and forfaiting that help companies have easy and instant access to money, thus helping them with managing their cash flow issues. Using the appropriate method of payment reduces the exposure to commercial risk, and thus, this decision needs to be taken with due diligence by the organizations.
