Bankers' Acceptances

From Financial Literacy Wiki

Bankers' Acceptances are actually promissory notes that stipulates a payment amount and a date at which it will be paid. This security arise during the course of increasing international trade.

For example, a Singapore firm might wish to import machines from a Japanese exporter. The Singapore firm will have its banker write a letter of credit (LOC) to the Japanese exporter guaranteeing the goods will be paid for. After receiving the LOC, the exporter will ship the goods and simultaneously prepare a draft on the domestic bank. This draft is taken to a Japanese bank together with supporting documents, such as the LOC and shipping documents, and the Japanese bank pays the exporter. The draft is then sent to the importer's banker, where it is accepted. At this point, a bankers' acceptance has been created, which may be returned to the Japanese bank or kept by the domestic bank, or sold in the open market.

This bankers' acceptance final payment will be made by the Singapore importer mentioned above or the accepting bank if the importer defaults. Acceptances are traded on a discount basis with the return to the owner consisting of the difference between the price paid and the acceptance's face value.

Since both the importer and the accepting bank have agreed to pay. default risk is minimal. They are usually used by borrowers who are either too small or too risky to use commercial papers. As a result, the rates are slightly above commercial papers rates.