Bankers' acceptance

Bankers' Acceptance is a short-term debt instrument issued by a company that is guaranteed by a commercial bank. Bankers' acceptances are issued as part of a letter of credit transaction in international trade, as they are used to ensure payment to the seller of goods and services.

Overview

A banker's acceptance (BA) is essentially a negotiable instrument, and it is similar to a post-dated check in that it promises to pay a specified amount to the holder at a future date. The difference is that the bank, rather than the account holder, guarantees payment. BAs are frequently used in international trade because of advantages for both sides. Exporters often feel safer relying on payment from a reputable bank than a business with which it has little if any history. Once the bank pays the exporter, it is the importer's responsibility to pay the bank the amount due on the BA.

Creation of a Banker's Acceptance

A banker's acceptance is created by a bank drawing a draft on itself, accepting that draft, and then obligating itself to pay its face amount at maturity. The bank does this on behalf of a customer who must repay the bank. The draft specifies the amount of funds, the date of the payment (or maturity), and the entity to which the payment is owed. After the bank adds its signature of "acceptance" to the draft, it becomes a binding obligation.

Trading of Bankers' Acceptances

Bankers' acceptances trade at a discount from face value on the money market. The difference between the purchase price and the face value of the BA is the investor's return. Bankers' acceptances are considered to be relatively low-risk investments since the bank and the borrower are liable for the amount that is due when the instrument matures.

Uses of Bankers' Acceptances

Bankers' acceptances can be used to finance both domestic and international trade. They can provide a secure short-term investment and can be a useful tool for money market mutual funds. In addition, they can be used in credit arrangements that involve a letter of credit.

See Also

• Commercial paper
• Letter of credit
• Money market
• Short-term debt

References

• Investopedia: Bankers' Acceptance
• Federal Reserve Bank of New York: Bankers' Acceptance