A Russian company, Alpha Inc, opens a $500,000 time letter of credit with its ba

Question

A Russian company, Alpha Inc, opens a $500,000 time letter of credit with its bank Vaneshnicom Bank, in favor of the beneficiary in the United States, Servitech College. The time letter of credit calls for the draft to be drawn on Bank of America at 90 days after the bill of lading date. Since the draft is drawn on Bank of America, they are taking the credit risk of Vaneshnicom Bank.

The goods are shipped on April 14, Alpha present documents required under the letter of credit to B of A on April 20, accompanied by a 90-day draft maturing on July 13.

Commission is 1.5% p.a. that would be charged by B of A.

6.4% acceptance discount rate

Servitech College's line of credit borrowing rate is 9.5% (fyi).

Once the banker's acceptance has been created, the exporter has two choices: What are they? and please calculate

Explanation / Answer

1) Wait until July 13 to get the $500,000, knowing that its credit risk is now that of Bank of America. If this option is picked, Servitech College will be charged a per annum commission of 1.5% ($ 937.50) representing Bank of America’s price for accepting the Vaneshnicome bank’s risk for 90 days.

2) On April 20, discount the draft with Bank of America at the banker’s acceptance discount rate of 6.4% plus the commission of 1.5%. In this example, Servitech College. would be discounting the banker’s acceptance for the time period of 90 days left until maturity at a rate of 7.9% based on a year of 360 days, giving a total discount of $9,875. Servitech College. will receive the net proceeds of $490,125.00.

A significant advantage to Servitech College is that it can finance this foreign receivable at a cheaper rate than under its bank line of credit, priced at one percent over the prime borrowing rate (9.5%).

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