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Bank Acceptance can help you in many ways and this is one of
the ways that would better explain what bank acceptance is.
Bank Acceptance is a draft is a legally binding order by one
party (the drawer) to a second party (the drawee) to make payment
to a third party (the payee). A simple example is a bank check—which
is simply an order directing a bank to pay a third party. The
three parties don't have to be distinct. For example, someone
might write himself a check as a simple means of transferring
funds from one bank account to another. In this case, the drawer
and payee are the same person. When a draft guarantees payment
for goods in international trade, it is called a bill of exchange.
A draft can require immediate payment by the second party
to the third upon presentation of the draft. This is called
a sight draft. Checks are sight drafts. In trade, drafts often
are for deferred payment. An importer might write a draft
promising payment to an exporter for delivery of goods with
payment to occur 60 days after the goods are delivered. Such
drafts are called time drafts. They are said to mature on
the payment date. In this example, the importer is both the
drawer and the drawee.
In cases where the drawer and drawee of a time draft are distinct
parties, the payee may submit the draft to the drawee for
confirmation that the draft is a legitimate order and that
the drawee will make payment on the specified date. Such confirmation
is called acceptance—the drawee accepts the order to
pay as legitimate. The drawee stamps ACCEPTED on the draft
and is thereafter obligated to make the specified payment
when it is due. If the drawee is a bank, the acceptance is
called a bankers acceptance (BA).
A bankers acceptance is an obligation of the accepting bank.
Depending on the bank's reputation, a payee may be able to
sell the bankers acceptance—that is, sell the time draft
accepted by the bank. It will sell for the discounted value
of the future payment. In this manner, the bankers acceptance
becomes a discount instrument traded in the money market.
Paying discounted value for a time draft is called discounting
the draft.
In international trade, bankers acceptances arise in various
ways. Consider two examples:
An importer plans to purchase goods from an exporter. The
exporter will not grant credit, so the importer turns to its
bank. They execute an acceptance agreement, under which the
bank will accept drafts from the importer. In this manner,
the bank extends credit to the importer, who agrees to pay
the bank the face value of all drafts prior to their maturity.
The importer draws a time draft, listing itself as the payee.
The bank accepts the draft and discounts it—paying the
importer the discounted value of the draft. The importer uses
the proceeds to pay the exporter. The bank can then hold the
bankers acceptance in its own portfolio or it can sell it
at discounted value in the money market.
In an alternative arrangement, the exporter may agree to
accept a letter of credit from the importer's bank. This specifies
that the bank will accept time drafts from the exporter if
the exporter presents suitable documentation that the goods
were delivered. Under this arrangement, the exporter is the
drawer and payee of the draft. Typically, the bank will not
work directly with the exporter but with the exporter's correspondent
bank. The exporter may realize proceeds from the bankers acceptance
in several ways. The bank may discount it for the exporter;
the exporter may hold the acceptance to maturity; or it may
sell the acceptance to another party.
Bankers acceptances are quoted in discount form. Maturities
are generally between one and six months, and they trade as
bearer instruments. Their credit quality is excellent. Not
only are they a primary obligation of the accepting bank,
but they are usually also a contingent obligation of the drawer.
Bankers acceptances trade at a spread over T-bills. The interest
rate at which they trade are called bankers acceptance rates
(or BA rates). The Fed publishes BA rates in its weekly H.15
bulletin. Those rates are a standard index used as an underlier
in various interest rate swaps and other derivatives.
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