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Difficulty: HardMeans of Payment in Foreign Trade

A Nigerian cocoa exporter entering into a contract with a new buyer in the United Kingdom seeks to eliminate credit risk by ensuring that a reputable bank guarantees payment upon presentation of specified shipping documents, rather than relying strictly on the buyer's creditworthiness. Which instrument of foreign payment fulfills this condition, and what is its main feature?

  1. An Irrevocable Letter of Credit, because the issuing bank undertakes a binding commitment to pay the exporter upon presentation of compliant shipping documents.Answer
  2. B
    A Bill of Lading, because it functions as an unconditional bank guarantee that automatically settles foreign trade debts upon shipment.
  3. C
    A Sight Bill of Exchange, because it directly adjusts national balance of payments reserves to guarantee private trade transactions.
  4. D
    A Certificate of Origin, because it provides legal assurance of bank settlement while confirming customs tariff classifications.

Answer

An Irrevocable Letter of Credit, because the issuing bank undertakes a binding commitment to pay the exporter upon presentation of compliant shipping documents.
An Irrevocable Letter of Credit is issued by an importer's bank and provides an independent, legally binding guarantee to pay the exporter upon presentation of strictly compliant shipping documents. This transfers the credit risk from the buyer to the issuing bank.

Step-by-Step Solution

1
Identify the exporter's requirement in international trade.
The exporter needs a payment mechanism where a financial institution (bank) guarantees payment upon document presentation to eliminate buyer default risk.
Trading with a new overseas buyer involves credit and political risk, requiring third-party bank security.
2
Evaluate the payment instruments against document-of-title shipping documents.
Letters of Credit substitute the creditworthiness of the buyer's bank for the buyer, guaranteeing payment against compliant shipping documents.
Shipping documents such as the Bill of Lading or Certificate of Origin support the transaction, but are not payment guarantees themselves.
3
Distinguish commercial instruments from macroeconomic trade metrics.
Balance of Payments is a statistical record of all economic transactions between residents of a country and the rest of the world, not an individual payment instrument.
Individual payment methods settle specific commercial contracts rather than adjusting macro reserves directly.

Key Concept

Letter of Credit as a Payment Guarantee in Foreign Trade
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Topics

Means of Payment in Foreign Trade

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