Good Essay About Finance Forum 7
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The five basic methods of payment in international trade are:
Prepayment: Under this method, the exporter will not ship goods until the payment has been remitted to the exporter by the buyer. This method provides the supplier of the goods the highest protection and has a disadvantage to the buyer because at times they are unwilling to be exposed to 100% risk of remitting the full amount upfront (Jeff, 2012).
Letter of Credit (LC): This is an instrument issued by the bank to the exporter on behalf of the importer promising to pay for the goods to the exporter (supplier) in case the buyer (importer) is unable to. This method has advantages in the sense that it provides security to the exporter that he will receive his payment as the bank is the guarantee, and it has advantages for the buyer as it does not have to pay upfront, but the risk prevails as the LC does not guarantee that good dispatched by the exporter will be according to the demand (Jeff, 2012).
Draft: This is a promise drawn by the exporter to the buyer to pay the face amount of draft. The buyer here is exposed to risk again, the exporter is protected to some extent but not in the way LC secures the international transaction (Jeff, 2012).
Open Account: Goods are shipped and delivered before the payment occurs. The advantage to importer in this option is higher as he can hold his payment till checking the order, but it holds its disadvantage for the exporter as they are at high risk.
Consignment: In this method, payment is made to the exporter once the goods are sold. It’s a win-win situation for the importer, but a highly risky method for exporter as he might not receive any money at all (Jeff, 2012).
The purchase will be made in the local currency and Letter of Credit will be issued in order to hedge the risk of financial loss (Export, 2013).
Export.gov (2013) Foreign Exchange Risk Management, Chapter 14, http://www.export.gov/tradefinanceguide/eg_main_043254.asp
Jeff M. (2012) International Financial Management, 11ed, Mason OH. South Western/ Cengage Learning.
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