Question

In 500 words, typed, essay format with intro, body and conclusion, in your own words answer the following question: Banker’s acceptances are closely affiliated with international transactions rather than domestic ones. Describe and provide an example of how this market works and why there is a need for the instrument.

Answer 1

Introduction: Banker’s acceptance is a negotiable piece of paper and this negotiable piece of paper works like a postdated check. The payment is guaranteed by the bank in case of a banker’s acceptance and this is unlike the case for a postdated check in which the payment is guaranteed by the account holder that has issued the postdated check. Banker’s acceptances are closely affiliated with international transactions rather than domestic ones.

Body: Banker’s acceptance is more frequently used in international trade and is less often used in domestic trades. This is because the element of risk is higher in case of an international trade and as such banker’s acceptance helps to finalize the transactions in such a manner so that there is relatively little risk or no risk at all to both the parties involved in the international trade.

In international trade there will be two parties just like in case of domestic trade – the buyer and the seller. The buyer will issue banker’s acceptance so as to be able to pay for the purchases without the need for borrowing money to make payment for the purchases. The seller that will receive the banker’s acceptance from the buyer will find banker’s acceptance as a guaranteed form of payment. This helps in eliminating the risk for the seller.

It should be noted that a banker’s acceptance is a negotiable instrument and hence the concerned bank will pay the holder the set amount of money on the set date (as set in the instrument).

Banker’s acceptance has more usage in the international market than in the domestic market. The risk is more pronounced in case of international buy and sale transactions with regards to payments and this is where banker’s acceptance comes into picture. A banker’s acceptance relies on the creditworthiness of the banking institution and as such the risk associated with the creditworthiness of the buyer is completely eliminated.

Banker’s acceptance provides a bridge between importers and exporters. In most of the international trade transactions the buyer and seller do not have established relationships. This creates a possible risk element with regards to payment. This risk element is not usually present in case of domestic sale and buy transactions as generally the buyer and the seller will either know each other or will be having information about each other so as to be able to determine the associated risk for doing business with the other party. In international transactions the risk is eliminated by banker’s acceptance that created a legally binding obligation for the payment. The buyer (or the importer) creates a time draft and presents this time draft to his bank. The bank, after accepting the draft, discounts it and transfers the payment to the seller (i.e. the exporter).

Conclusion: We can conclude that banker’s acceptance is an effective instrument to eliminate the risk of payments in international trade. This risk is less pronounced in domestic trade and as such banker’s acceptance is used more in case of international trade.

(Total word count = 500 words)