Question

Which of the following trade payment methods provides the most security for the seller in an international trade transaction?

	A.	Open account
	B.	Letter of credit
	C.	Countertrade
	D.	Documentary collection

Answer 1

International trade presents a spectrum of risk, which causes uncertainty over the timing of payments between the exporter (seller) and importer (foreign buyer).

Exporters want to receive payment as soon as possible, preferably as soon as an order is placed or before the goods are sent to the importer.

Importers want to receive the goods as soon as possible but to delay payment as long as possible, preferably until after the goods are resold to generate enough income to pay the exporter.

A) An open account transaction

• It is a sale where the goods are shipped and delivered before payment is due.
• Payment due in international sales is typically in 30, 60 or 90 days.
• This is one of the most advantageous options to the importer in terms of cash flow and cost, but it is consequently one of the highest risk options for an exporter.

B) Letters of credit (LCs)

• LCs are one of the most secure instruments available to international traders.
• An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents.
• The buyer establishes credit and pays his or her bank to render this service.
• An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyer’s foreign bank.

C) A documentary collection (D/C)

• It is a transaction whereby the exporter entrusts the collection of the payment for a sale to its bank (remitting bank), which sends the documents that its buyer needs to the importer’s bank (collecting bank), with instructions to release the documents to the buyer for payment.
• Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents.
• D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance).
• The collection letter gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the eventof non-payment. .
• D/Cs are generally less expensive than LCs.

D) Countertrade

• It is a reciprocal form of international trade in which goods or services are exchanged for other goods or services rather than for hard currency.
• This type of international trade is more common in lesser-developed countries with limited foreign exchange or credit facilities.

Therefore LCS are more secured form of payments in international trade activities followed by D/Cs.