Documentary Credits Overview

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Questions and Answers

What defines a contingent liability?

A possible obligation dependent on uncertain future events outside the company's control. (correct)

An obligation that will be definitively confirmed regardless of future events.

A guaranteed liability that affects the company's cash flow.

An obligation that is recognized in the financial position statement.

What is the purpose of a pledged asset?

To secure a debt or loan by transferring a valuable possession to a lender. (correct)

To ensure that the borrower can get additional funding without collateral.

To provide a guaranteed investment return to the borrower.

To represent an obligation that must be reported on the balance sheet.

What characterizes 'usance' in business transactions?

The period between contract negotiation and payment.

The duration granted for the buyer to inspect goods before payment.

The process of shipping goods to the buyer.

The time between document presentation and payment. (correct)

In a typical documentary credit transaction, which aspect must BOTH parties agree on?

The latest shipment date and documentary requirements. Signup and view all the answers

What type of credit is characterized by having no possibility of alteration after issuance?

Irrevocable credit. Signup and view all the answers

Which of the following is NOT a responsibility discussed in a documentary credit?

Repayment schedule for the buyer. Signup and view all the answers

What does the concept of 'validity of the credit' refer to?

The period during which documents can be presented and the credit remains in effect. Signup and view all the answers

Which document is crucial for documenting the shipment in a credit transaction?

Transport document. Signup and view all the answers

What is the primary role of the issuing bank in the documentary credit process?

To provide a guarantee for payment based on presented documents. Signup and view all the answers

What must the buyer complete to initiate the documentary credit process?

An application form for the bank. Signup and view all the answers

Which document type is commonly used by banks when issuing documentary credits?

SWIFT MT 700 message type. Signup and view all the answers

What form of security might a bank require to protect against potential losses?

A pledge over the buyer’s assets. Signup and view all the answers

What information is NOT typically required by the issuing bank from the buyer during the application process?

Projected profit from the transaction. Signup and view all the answers

How does the bank account for the documentary credit once issued?

As a contingent liability. Signup and view all the answers

What happens if the buyer does not have the seller's bank details?

The issuing bank advises the credit through a correspondent bank. Signup and view all the answers

What occurs after the issuing bank assesses the buyer's financial standing?

The bank establishes a documentary credit facility if needed. Signup and view all the answers

What information is included in the issued documentary credit?

The documentary credit reference number Signup and view all the answers

What role does the advising bank play in the process of documentary credit?

It confirms the credit after assessing risk Signup and view all the answers

What should the seller do after receiving the documentary credit?

Verify the contents and request amendments if necessary Signup and view all the answers

How does the nominated bank handle the documents after they are presented by the seller?

It checks the documents and sends them to the issuing bank Signup and view all the answers

What is the possible outcome if the documents presented to the nominated bank are compliant?

The nominated bank pays the seller in accordance with the credit's terms Signup and view all the answers

What does the issuing bank do after receiving the documents from the nominated bank?

It checks the documents and pays the nominated bank based on the credit terms Signup and view all the answers

What type of payment might the seller receive if the documentary credit states it is available at sight?

Payment is made immediately after document review Signup and view all the answers

What condition must be met for the nominated bank to pay the seller?

The documents presented must be compliant with the credit Signup and view all the answers

Study Notes

Operation Example - Documentary Credits

Contingent Liabilities: Possible obligations confirmed by uncertain future events, not wholly under the entity's control. Not recognised in the balance sheet but disclosed in notes.
Pledged Asset: A valuable possession transferred to a lender to secure a debt or loan.
Usance: The time between document presentation and payment.
Buyer and Seller Contract Details: Buyer and seller agree on purchase/sale terms, using a documentary credit. Details include nature of credit (irrevocable, confirmed, transferable), payment terms (sight, acceptance, deferred), and other details (currency, amount, and sales terms).
Validity of Credit: Expiry date for document presentation and period for presentation.
Shipment Issues: Details on part shipments, transhipment, transport documents, other documentary requirements.
Description of Goods: Description of the goods is essential
Insurance Requirements: Insurance required for the goods.
Confirmation: Confirmation of credit by a bank in the exporter's country.
Responsibility for Bank Charges: Who is responsible for bank charges.
Inspection of Goods: Whether inspection is necessary before shipment.
Buyer Approaches Issuing Bank: Buyer requests a documentary credit from its bank to secure a payment to the seller. This means checking the buyer's financial standing.
Issuing Bank Risk Assessment: The issuing bank assesses security against possible loss and may require security. Methods of securing this can be independent of a transaction such as charges or pledges over buyer assets, and/or security from documents.
Issuing Bank Documentary Credit (SWIFT MT 700): The issuing bank uses message type MT 700 via SWIFT and includes issuing bank details, the credit reference number, date, and instructions that conform with availability of the credit.
Advising Bank: The bank that sends the credit to the seller (beneficiary).
Seller (Beneficiary) Checks Contents: Seller verifies the documentary credit details.
Seller Despatches Goods: Seller prepares and sends the goods to the buyer.
Seller Presents Documents: Seller delivers necessary documents to the nominated bank.
Nominated Bank Pays Seller: The nominated bank checks documents and pays the seller according to the terms, immediately, or at a later date (usance).
Issuing Bank Pays Nominated Bank: The issuing bank pays the nominated bank, considering the credit terms.
Issuing Bank Sends Documents to Buyer: Issuing bank sends documents to the buyer after confirmation of the buyer's obligations fulfilled.
Buyer Collects Goods: Buyer uses the documents to collect goods.

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Description

This quiz covers essential concepts related to documentary credits, including terms like contingent liabilities, pledged assets, and usance. You will learn about buyer and seller contracts, validity of credit, shipment issues, and insurance requirements. Test your understanding of these important financial concepts.