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Introduction to Trade Finance
Article · January 2003
Source: RePEc
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Bernardo Batiz-Lazo
Bangor University
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PART 1: BASIC CONCEPTS AND OPERATIONS 1
1 WHAT IS INTERNATIONAL BANKING? 1
1.1 THE ECONOMIC ROLE OF BANKS 1
1.2 WHO ARE INTERNATIONAL BANKS? 2
1.3 REVIEW 3
1.3.1 SUMMARY 3
1.3.2 QUESTIONS 3
2 ASSOCIATED RISKS 4
2.1 PRODUCT BASED RISKS 5
2.2 CREDIT RISK 5
2.3 SETTLEMENT RISK 7
2.4 ENVIRONMENT RELATED RISKS 8
2.5 CURRENCY RISK 9
2.6 COUNTRY RISK 10
2.6.1 SOVEREIGN RISK 11
2.6.2 TRANSFER RISK 11
2.7 REVIEW 12
2.7.1 SUMMARY 12
2.7.2 QUESTIONS 12
3 BASIC OPERATIONS IN FX MARKETS 13
3.1 OVERVIEW 13
3.2 DIRECT AND INDIRECT RATES 14
3.3 CROSS-RATES 15
3.4 REVIEW 16
3.4.1 SUMMARY 16
3.4.2 QUESTIONS 16
4 INSTRUMENTS TO MANAGE CURRENCY RISK 16
4.1 SPOT AND FORWARDS 16
4.2 FORWARD AGREEMENTS 18
4.3 FUTURE CONTRACTS 19
4.4 CURRENCY OPTIONS 24
4.5 REVIEW 27
4.5.1 SUMMARY 27
4.5.2 QUESTIONS 28
5 PRICING FOREIGN EXCHANGE TRANSACTIONS 29
5.1 THE INTEREST RATE PARITY THEOREM 29
5.2 INVESTING AT HOME OR ABROAD? 29
5.3 CURRENCY ARBITRAGE 31
5.4 PREMIUM IN THE FORWARD MARKET 32
5.5 REVIEW 34
5.5.1 SUMMARY 34
5.5.2 QUESTIONS 34
6 THE EUROCURRENCY MARKET 35
6.1 THEORETICAL UNDERPINNINGS 35
6.1.1 SCOPE OF BANKING MARKETS 35
6.1.2 DOMESTIC MARKET 35
6.1.3 FOREIGN SEGMENT 35
6.1.4 OFF-SHORE MARKETS 36
6.2 BRIEF HISTORY (1960-1995) 37
6.2.1 ORIGINS OF INTERNATIONAL MARKETS 37
6.2.2 ORIGIN OF EUROMARKETS 38
6.2.2.1 BIRTH 38
6.2.2.2 SECONDARY DEVELOPMENTS 40
6.2.2.3 INSTITUTIONAL DEVELOPMENTS 40
6.2.3 LATE DEVELOPMENTS 41
6.3 PRICING TRANSACTIONS 43
6.3.1 OVERVIEW 43
6.3.2 NEGOTIABLE CERTIFICATES OF DEPOSIT 44
6.3.3 EURODOLLAR COMMERCIAL PAPER 45
6.3.4 LONDON EURODOLLAR BANKERS' ACCEPTANCES 45
6.4 EUROBOND ANALYSIS 46
6.4.1 BOND RATING 46
6.4.2 COUPON 47
6.4.3 TERM 48
6.5 BOND PRICING 48
6.6 REVIEW 50
6.6.1 SUMMARY 50
6.6.2 QUESTIONS 51
REFERENCES 52
PART 2: TRADE FINANCE 1
1 OVERVIEW 1
2 TRADITIONAL METHODS 2
3 EXPORTER RISK INSTRUMENTS 3
3.1 CONSIGNMENT 3
3.2 OPEN ACCOUNT SALE 4
3.3 SECURED BANK OVERDRAFT 4
3.4 DOCUMENTS FOR COLLECTION 4
3.5 REVIEW 5
3.5.1 SUMMARY 5
3.5.2 QUESTIONS 5
4 SHARED RISK INSTRUMENTS 6
4.1 CREDIT INSURANCE 6
4.2 SHORT TERM GUARANTEES 6
4.3 REVIEW 7
5 THIRD PARTY RISK 8
5.1 CONFIRMING HOUSE ARRANGEMENT 8
5.2 BUYER CREDIT ARRANGEMENTS 8
5.4 LINES OF CREDIT 10
5.4 EXPORT LEASING ARRANGEMENTS 10
5.5 REVIEW 10
5.5.1 SUMMARY 10
5.5.2 QUESTIONS 11
6 ALTERNATIVES TO BANK FINANCE 12
6.1 REDUCED EXPOSURE 12
6.2 DISCOUNTING AND DRAFTS 12
6.3 FORFEITING 13
6.4 INTERNATIONAL FACTORING 14
6.5 REVIEW 15
6.5.1 SUMMARY 16
6.5.2 QUESTIONS 16
7 LETTERS OF CREDIT 17
7.1 MAIN CHARACTERISTICS 17
7.2 CONFIRMED LETTERS OF CREDIT 17
7.3 REVOCABLE LETTERS OF CREDIT 18
7.4 TRANSFERABLE LETTERS OF CREDIT 19
7.5 RISK IN LETTERS OF CREDIT 20
7.6 REVIEW 20
7.6.1 SUMMARY 20
7.6.2 QUESTIONS 21
8 DOCUMENTATION FOR LETTERS OF CREDIT 22
8.1 OVERVIEW 22
8.2 BILL OF LADING 22
8.3 INVOICES 23
8.4 SPECIAL REQUIREMENTS 23
8.5 REVIEW 24
8.5.1 SUMMARY 24
8.5.2 QUESTIONS 25
9 GOVERNMENT STIMULUS TO TRADE FINANCE 25
10 THE OECD ARRANGEMENT 26
10.1 OVERVIEW 26
10.2 MIXED CREDITS 27
10.3 GUARANTEES AND INSURANCE 27
11 NEW TRADE FINANCE INNOVATIONS 29
11.1 ELECTRONIC LETTERS OF CREDIT 29
11.2 CAPITAL MARKET INSTRUMENTS 29
11.3 EXPORT TRADE NOTES 30
11.4 CURRENCY SWAPS 30
11.5 REVIEW 32
11.5.1 SUMMARY 33
11.5.2 QUESTIONS 33
12 COUNTER TRADE 34
12.1 MAIN CHARACTERISTICS 34
12.2 COUNTER TRADE BANKING 35
12.3 MOST COMMON TRANSACTIONS 37
12.3.1 COUNTERPURCHASE 37
12.3.2 BUY-BACK 37
12.3.3 OFFSET 37
12.3.4 CLEARINGS 38
12.3.5 SWITCH TRADING 38
12.4 REVIEW 39
12.4.1 SUMMARY 39
12.4.2 QUESTIONS 39
GLOSSARY OF SELECTED TERMS 40
REFERENCES 45
PART 3: OTHER ISSUES 1
1 GOVERNING BODIES 1
1.1 INTERNATIONAL MONETARY FUND 1
1.2 BASEL COMMITTEE 2
1.2.1 INTENTIONS 2
1.2.2 BASEL CONCORDAT 3
1.4 INSTITUTIONS OF THE EUROPEAN UNION 4
1.4.1 ORIGINS 4
1.4.2 A FRAMEWORK FOR EMU 4
1.4.3 SINGLE MARKET IN FINANCIAL SERVICES 6
1.4.4 EUROPEAN MONETARY SYSTEM 7
1.4.5 LAST STAGE OF THE EMU 9
1.4.6 BANKING REGULATION IN EUROPE 10
1.4.6.1 REGULATION OF MARKET ENTRY 11
1.4.6.2 HARMONIZATION OF REGULATION 11
1.4.6.3 CREATION OF SINGLE MARKET 11
1.4.7 CAPITAL ADEQUACY 13
1.5 SUMMARY 15
2 TYPES OF ESTABLISHMENT 16
2.1 CROSS-BORDER TRANSACTIONS 16
2.2 REPRESENTATIVE OFFICES 17
2.3 FOREIGN BRANCHES 18
2.4 FOREIGN AFFILIATES AND SUBSIDIARIES 18
2.5 CORRESPONDENCE BANKING 19
2.6 SUMMARY 21
3 ELECTRONIC PAYMENT SYSTEMS 23
3.1 OVERVIEW 23
3.2 FEATURES OF CROSSS-BORDER PAYMENTS 23
3.3 MAJOR INSTITUTIONS 25
3.3.1 INTERLINKING SYSTEMS 26
3.3.2 RETAIL SYSTEMS 27
3.3.3 WHOLESALE SYSTEMS 28
3.3.4 SETTLEMENT OF SECURITIES 28
3.4 SUMMARY 29
REFERENCES 30
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