Question

There are a number of methods used in financing international trade. Explain how the medium-term capital goods financing (Forfaiting) method is used to finance a trade transaction.

Answer 1

Forfaiting is the process of purchasing of accounts receivable whose credit terms are longer than 90 to 180 days. It is the normal length to maturity in factoring of receivables. The purchase is without recourse. Forfaiting is a type of financing used to finance the sale of capital goods.

It is designed for medium term trade financing. And, the medium term risk is converted into a series of short term loans. Thus it is a hybrid form of export financing.

For example if a company is exporting an asset which is of high cost and the financing is for five years period. Here the five year note can be broken into a series of 10 months notes and each can be priced for specific time to maturity.

It consists of purchasing of claims arising out of export trade transactions which will be due on a specific date in future. There is no recourse for the exporter, who is the seller of the claims. The exporter sells promissory notes signed by the exporter in favor of the importer. Exporter is called as forfaitiste and the buyer of the claims is forfaiteur. The forfait, which is usually a bank, buys the notes at a discount from face value and thus, the transaction risk is shifted to third party.