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Mitigating Techniques for Commercial Risk/Letter of Credit

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Unit 3.5-Mitigating Techniques for Commercial Risk 

Introduction | Commercial Banks | Loans | Letter of Credit | Draft Collection | Accounts Receivable | Governments | Factoring | Forfaiting | Banker's Acceptances | Credit Insurance | Summary | Resources | Activities | Assessment

Letter of Credit

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The letter of credit process begins after a buyer and seller conclude a sales contract providing for payment by a letter of credit. The buyer then instructs his bank--the issuing bank--to issue a letter of credit in favor of the seller. The sales contract may call for either a

  • sight letter of credit pursuant to which the issuing bank agrees to make payment upon presentation of a sight draft and the required documents, or
  • time letter of credit pursuant to which the issuing bank agrees to accept a time draft and pay at maturity upon its presentation with confirming documents.

The issuing bank then delivers or transmits the credit to a bank in the seller’s country--the advising bank--that may also be the asked to confirm the credit. The advising/confirming bank notifies the seller that the credit has been issued. Once the seller has been advised that a letter of credit has been issued in his/her favor and is certain that he/she can satisfy the stated terms and conditions, the goods are shipped and required shipping documents assembled.

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