What it means
The instrument starts life as a time draft, an order to pay a stated amount on a stated future date. When a bank writes accepted across it, the obligation becomes the bank's rather than the importer's, which is exactly what a nervous exporter wants.
The exporter then has a choice. It can hold the acceptance to maturity and collect the face value, or sell it immediately into the money market at a discount and take cash today.
Pricing works on a discount basis rather than as interest added on top. The investor pays less than face value, the difference being the return, and the market conventionally uses a 360-day year for the calculation.
The bank charges separately for its guarantee. An acceptance commission, usually quoted as an annual percentage of face value, compensates the bank for taking the credit risk, and it is this fee plus the discount that makes up the true cost to the trading parties.
Acceptances have faded in many markets, displaced by letters of credit, supply chain finance and cheap bank lending. They remain useful where a seller wants bank-quality credit risk and a tradable piece of paper rather than an ongoing relationship with the buyer's bank.
In practice
Real-world examples.
Example
A furniture importer agrees to pay a supplier 120 days after shipment. Its bank accepts the draft, the supplier sells the acceptance the same week for cash, and the importer repays the bank on day 120 out of retail takings.
Example
A money market fund buys $2,000,000 of 90-day acceptances from a highly rated accepting bank at a 4.8% discount rate. The discount is $2,000,000 x 0.048 x (90 / 360) = $24,000, so the fund pays $2,000,000 - $24,000 = $1,976,000 and collects the full $2,000,000 at maturity.
Example
A commodity trader compares a banker's acceptance with a straight overdraft and finds the acceptance cheaper all in, because its own credit standing is weaker than its bank's. It uses acceptances for seasonal purchases and keeps the overdraft as a backup line.
Formula
Calculation
Discount = face value x discount rate x (days to maturity / 360)
Proceeds = face value - discount
An exporter holds a 180-day banker's acceptance with a face value of $500,000 and sells it at a discount rate of 4.20%. The discount is $500,000 x 0.0420 x (180 / 360) = $500,000 x 0.0420 x 0.5 = $10,500, so the proceeds are $500,000 - $10,500 = $489,500.
The accepting bank charges an acceptance commission of 1.25% a year, which over 180 days is $500,000 x 0.0125 x 0.5 = $3,125. If the exporter bears that fee it nets $489,500 - $3,125 = $486,375 today instead of $500,000 in six months.
From the investor's side the simple annualised yield is the discount divided by the amount actually invested, scaled up to a year: ($10,500 / $489,500) x (360 / 180) = 0.021450 x 2 = 0.0429, or 4.29%. Note that this yield is higher than the 4.20% discount rate, because the discount rate is quoted on face value while the yield is earned on the smaller sum invested.Case study
Seen in the real world.
Calderon Textiles is a fictional garment exporter used here to illustrate the instrument in use. It won a $500,000 order from a first-time overseas buyer offering 180-day payment terms, which it had no chance of funding from its own working capital.
The buyer's bank accepted a 180-day draft for the full amount, and Calderon sold that acceptance at a 4.20% discount rate, receiving $489,500 immediately. The buyer paid the $3,125 acceptance commission as part of the negotiated terms.
Calderon's own borrowing rate was 9%, so funding the receivable itself would have cost $500,000 x 0.09 x 0.5 = $22,500 for the six months, against the $10,500 discount it actually gave up: a saving of $22,500 - $10,500 = $12,000. The illustrative point is that the exporter converted an unknown buyer's promise into a bank's promise, then converted that into cash, without ever taking a credit view on the buyer.
Watch out
Common mistakes.
- Treating an acceptance as the importer's debt once it has been accepted. The accepting bank is primarily liable, which is the whole reason the paper can be traded.
- Using a 365-day year in the discount calculation. The money market convention for acceptances is 360 days, and using 365 understates the discount.
- Forgetting the acceptance commission when comparing costs. The discount is only part of the price, and the bank's fee for lending its name is the other part.
Questions
People also ask.
How long do acceptances usually run?
Most have maturities between 30 and 180 days, matching the shipping and selling cycle of the goods behind them.
What happens if the importer fails to pay the bank at maturity?
The bank still pays the holder and then pursues the importer, which is why banks underwrite the customer carefully before agreeing to accept a draft.
Is a banker's acceptance the same as a letter of credit?
No, a letter of credit is a conditional undertaking to pay if documents are presented correctly, while an acceptance is an unconditional obligation that already exists and can be sold on.
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