How do letters of credit and drafts work together? How does this create one of the...

How do letters of credit and drafts work together? How does this create one of the most liquid money market instrument?

Expert Solution

In order to receive the payment it is important for the beneficiary to present a draft with all the letters of credit with specified documents. Draft acts a written order by which the party that creates it can order another party to pay money to a third party. A draft is also called a bill of exchange.

There are two types of drafts: sight and time.

What is a sight draft?

A sight draft is payable as soon as it is presented for payment. The bank is allowed a reasonable time to review the documents before making payment.

What is a time draft?

A time draft is be payable until the lapse of a particular time period stated on the draft.A bank has to accept the draft when the documents comply with the terms . Banks have reasonable time for examining the documents.The issuing bank is obligated to accept drafts and pay them at maturity.

A letter of credit is a guarantee letter from a bank that guarantees that the seller will recieve the correct amount of money on the correct time. If the buyer fails to makes the payment or becomes unable to pay the money of the purchase or can only pay a certain amount of money the bank will be required to cover the full or remaining amount of the purchase. This states that in no case the seller will lose his money . This is the reason why this create one of the most liquid money market instrument.

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Rahul Sunny answered 1 year ago

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