CAF - Reference

Glossary of Financing Terminology

Introduction

This Glossary contains a listing of terms that appear frequently in our written materials. The purpose of this Glossary is to define these important terms and to clarify the meanings so as to eliminate misconceptions. In compiling this Glossary, we utilized various reference sources including dictionaries, encyclopedias, academic materials, government reports, professional journals, technical manuals, research monographs, legal publications, and distinguished economic and financial periodicals. We hope that this Glossary is helpful and informative.

Aval

An Aval is a written undertaking of guaranty in the form of a signature on a Promissory Note or Bill of Exchange, usually by a bank or other guarantor. The signatory engages an irrevocable and unconditional guaranty for payment by the guarantor in the event of default by the issuer of the paper. It comes from continental law, the Code Napoléon. It is a very simple and clear undertaking and is not dependent upon the performance of the trade contract that gives rise to the Promissory Note or Bill of Exchange. This undertaking insures the transferability of the Note or Bill on which the Aval appears. An Aval contains the words "Par Aval" and the signature(s) of an authorized official(s) of the entity providing the guaranty. In effect, the Aval signer on the instrument becomes the debtor. Once issued, an Aval becomes inseparable from the instrument. Avals of Promissory Notes and Bills of Exchange generally arise in the course of forfaiting transactions.

The Aval is not legally recognized in every country where forfaiting is conducted. For example, it is unknown to English law. Nevertheless, since an Aval is an endorsement of a Note or Bill, it is probable that a signatory of an Aval would have the same practical legal obligations in the United Kingdom as he would have in countries where Avals are legally known.

An Aval of a Promissory Note obligates the maker of the Aval as an irrevocable and unconditional guarantor for the repayment of the loan principal amount and all due interest specified by the Note.

Bill of Exchange

A Bill of Exchange is a debt instrument drawn by the exporter (seller) of the goods on the account of the importer (buyer) and accepted by the buyer as his obligation. The United Kingdom Bills of Exchange Act of 1882 defines a Bill of Exchange as:

"An unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed rate or at a determinable future time, a certain sum in money to, or to the order of, a specified person or to a bearer."

The Uniform Law on Bills of Exchange and Promissory Notes, as drafted by the Geneva Convention on Bills of Exchange of 1932, stipulates that:

A Bill of Exchange contains:

The term Bill of Exchange inserted in the body of the instrument and expressed in the language employed in drawing up the instrument.
An unconditional order to pay a determinant sum of money.
The name of the person who is to say (drawee).
A statement of the time of payment.
A statement of the place where payment is to be made.
The name of the person to whom or to whose order payment is to be made.
A statement of the date and of the place where the Bill of Exchange is issued.
The signature of the person who issues the Bill of Exchange (drawer).

Article 3 of the U.S. Uniform Commercial Code (UCC) is the statutory law in the United States, governing commercial paper (Checks, Promissory Notes, Bills of Exchange, Trade Acceptances, and similar instruments). It covers the various elements and requirements of a negotiable instrument in all states, except Louisiana, which is governed by Code Napoléon (French Code), its legal effect, the rights of the parties thereof, and other related legal matters.

Under the Commercial Paper Article of the UCC, a writing to be a negotiable instrument must:

Be signed by the maker or the drawer.
Contain an unconditional promise or order to pay a sum certain in money and no other promise, order, obligation, or power given by the maker or drawer except as authorized by the UCC. A sum certain in money includes foreign money.
Be payable on demand or at a definite time.
Be payable to order or to bearer.

If a "draft" instrument, conforming to these provisions of the Commercial Paper Article of the UCC, is an order, it is defined as a Bill of Exchange.

A Bill of Exchange is transferred or transmitted by endorsement. This simple process, evidenced by the signature of the beneficiary on the Bill, is accompanied by the use of the words "without recourse" in the endorsement. The intention of the endorser by including these words is to free himself from any responsibilities in respect of the obligation. One of the principles of forfaiting is the assumption of all repayment risks by the forfaiter. Without the use of these words, the endorser would remain liable as a guarantor of the obligation.

According to Article 9 of the International Convention for Commercial Bills established by the Geneva Conference of 1930 expressly states that "the drawer [of a bill of exchange] guarantees both acceptance and payment. He may release himself from guaranteeing acceptance, but any stipulation by which he releases himself from the guarantee of payment is deemed to be not written." Thus, the drawer of a Bill of Exchange, the exporter, may not be liable as its endorser but will always be liable as its drawer. For this reason, many exporters favor Promissory Notes over Bills of Exchange as payment instruments.

Bond

A bond is a form of collateral that a prospective borrower may directly pledge to a major bank to secure the bank's issuance of a Standby Letter of Credit, Letter of Guarantee, or Guarantee Par Aval of Promissory Notes.

All bonds are simply contracts between a lender and borrower by which the borrower promises to repay a loan with interest. However, bonds can take on many additional features and/or options that can complicate the way in which prices and yields are calculated. The classification of a bond depends on its type of issuer, priority, coupon rate, and redemption features.

1. Bond Issuers

The major determiner of a bond's credit quality, the issuer is one of the most important characteristics of a bond. There are significant differences between bonds issued by corporations and those issued by a state government/municipality, or national government. In general, securities issued by the Federal government have the lowest risk of default while corporate bonds are considered more risky. Of course, there are always exceptions to the rule, so, in rare instances, a very large and stable company could have a bond rating greater than a municipality. It is important to point out, however, that, like corporate bonds, government bonds carry various levels of risk: because all national governments are different, so are the bonds they issue.

International bonds (government or corporate) are offered in differing currencies, which increases their complications to investors. That is, these types of bonds are issued within a market that is foreign to the issuer's home market, but some international bonds are issued in the currency of the foreign market and others are denominated another particular currency. Here are some types of international bonds:

The definition of the eurobond market can be confusing because of its name. Although the Euro is the currency used by participating European Union countries, eurobonds refer neither to the European currency nor to a European bond market. A eurobond, instead, refers to any bond that is denominated in a currency other than that of the country in which it is issued. Bonds in the eurobond market are categorized according to the currency in which they are denominated. As an example, a eurobond denominated in Japanese Yen but issued in the U.S. would be classified as a euroyen bond.
Foreign bonds are denominated in the currency of the country into which a foreign entity issues the bond. An example of such a bond is the Samurai bond, which is a yen-denominated bond issued in Japan by an American company. Other popular foreign bonds include Bulldog and Yankee bonds.
Global bonds are structured so that they can be offered in both foreign and eurobond markets. Essentially, global bonds are similar to eurobonds but can be offered within the country whose currency is used to denominate the bond. As an example, a global bond denominated in yen could be sold to Japan or any other country throughout the eurobond market.

2. Priority

In addition to the credit quality of the issuer, the priority of the bond is a determiner of the probability that the issuer will repay the investor's money. The priority indicates your place in line should the company default on payments. If an investor holds an unsubordinated (senior) security and the issuing company defaults, then the investor would be first in line to receive payment from the liquidation of the assets of the issuing company. On the other hand, if the investor owned a subordinated (junior) debt security, then the investor would receive payment only after the senior debt holders have received their share of the proceeds.

3. Coupon Rate

Bond issuers may choose from a variety of types of coupons, or interest payments.

Straight, plain vanilla, or fixed-rate bonds pay an absolute coupon rate over a specified period of time. Upon maturity, the last coupon payment is made along with the par value of the bond.
Floating rate debt instruments or floaters pay a coupon rate that varies according to the movement of the underlying benchmark. These types of coupons could, however, be set to be a fixed percentage above, below, or equal to the benchmark itself. Floaters typically follow benchmarks such as the three, six, or nine-month T-bill rate or LIBOR.
Inverse floaters pay a variable coupon rate that changes in direction opposite to that of short-term interest rates. An inverse floater subtracts the benchmark from a set coupon rate. For example, an inverse floater that uses LIBOR as the underlying benchmark might pay a coupon rate of a certain percentage, say 6%, minus LIBOR.
Zero coupon or accrual bonds do not pay a coupon. Instead, these types of bonds are issued at a deep discount and pay the full face value at maturity.

4. Redemption Features

Both investors and issuers are exposed to interest-rate risk since they are locked into either receiving or paying a set coupon rate over a specified period of time. For this reason, some bonds offer additional benefits to investors or more flexibility for issuers:

Callable or a redeemable bond feature gives the bond issuer the right, but not the obligation, to redeem its issue of bonds before the bond's maturity-the issuer, however, must pay the bond holders a premium. There are two subcategories of these types of bonds: American callable bonds and European callable bonds. American callable bonds can be called by the issuer any time after the call protection period, while European callable bonds can be called by the issuer only on pre-specified dates.
The optimal time for issuers to call their bonds occurs when the prevailing interest rate is lower than the coupon rate they are paying on the bonds. After calling its bonds, the issuing company could refinance its debt by reissuing bonds at a lower coupon rate.
Convertible bonds give bondholders the right, but not the obligation, to convert their bonds into a predetermined number of stock shares at predetermined dates prior to the bond's maturity. This applies only to corporate bonds.
Puttable bonds give bondholders the right, but not the obligation, to sell their bond back to the issuer at a predetermined price and date. These bonds generally protect investors from interest-rate risk. If prevailing bond prices are lower than the exercise par value of the bond, resulting from interest rates being higher than the bond's coupon rate, it is optimal for investors to sell their bond back to the issuer and reinvest their money at a higher interest rate.

Unlimited Types of Bonds
All of the characteristics and features described above can be applied to a bond in practically unlimited combinations. For example, one could theoretically arrange to have a Malaysian corporation issue a subordinated Yankee bond paying a floating coupon rate of LIBOR + 1% that is callable at the choice of the issuer on certain dates of the year. The possibilities are in deed endless.

Demand Guarantee

A demand guarantee is an undertaking by a bank or other financial institution for payment of a stated or maximum sum of money against a demand for payment and documents as stipulated in the guarantee. Many demand guarantees are payable on first demand without any additional documents, which reflects their origin in replacing cash deposits, although increasingly, guarantees require at least a statement indicating that the principal is in breach. Demand guarantees are especially common in construction and project contracts and are frequently required by Middle Eastern customers.

There are two basic ways of issuing a demand guarantee - a direct guarantee or an indirect guarantee. A direct guarantee arises when a seller's bank provides the guarantee directly to the buyer with the seller giving the bank a counter-indemnity. However, there are cases, either due to local regulations or commercial practice, where the buyer will insist that its own bank provides the guarantee. This is known as an indirect guarantee wherein the seller will ask his bank to arrange for issue of the guarantee by a bank local to the buyer. The seller's bank will provide a counterguarantee to the local bank with the seller providing a counter-indemnity to his bank as before.

Demand guarantees are used in a number of different contexts. The principal ones are:

Tender or Bid Guarantee
Performance Guarantee
Advance Payment Guarantee
Retention Guarantee
Warranty Guarantee

A fundamental feature of demand guarantees under English law is the guarantee is completely separate from the underlying contract (i.e. the contract for sale of goods or services) between the buyer and the seller. This feature is incorporated into the Uniform Rules of Demand Guarantees (URDG) of the International Chamber of Commerce. Additionally, the guarantee given by the bank to the buyer is separate from the counter-indemnity given by the seller and also from any counter-guarantee given by the seller's bank to the buyer's bank in an indirect guarantee. This means that if a written demand is made by the buyer, accompanied by any additional documents called for under the guarantee, payment must be made, regardless of whether or not the seller has failed in any of its contractual obligations. This leads on to one of the problems of issuing a demand guarantee, that of unfair calling. Other problems include a balance sheet liability for the seller when the guarantee is issued, which additionally could be open ended if the buyer refuses to agree to an expiry date for the guarantee and also the possibility of the buyer demanding an extension to the guarantee, which if refused leads to a demand for payment (called 'extend or pay' demands). Exporters can protect themselves against 'unfair' calling by obtaining appropriate insurance.

Research has shown that the most significant problems are related to the balance sheet liability and the lack of expiry date in many demand guarantees. ICC first published Uniform Rules for Contract Guarantees (Publication Number 325) in 1978. These rules did not gain much acceptance mainly due to the requirement for a judgment or arbitral award or the seller's written approval of the claim and its amount as a condition of the buyer's right to payment. As noted above, demand guarantees were developed to replace cash deposits and the requirement of such paperwork took away the on demand nature of these instruments. The ICC's URDG were published in 1992 and designed to be more in accordance with established bank guarantee practice, where most demand guarantees are payable on first written demand. However, the URDG do seek to provide some protection against unfair calling.

It is worth noting that standby letters of credit can be seen as meeting the same purpose as a guarantee. They originated in the United States, where banks were not normally permitted to issue guarantees. Thus, they have developed into a financial support instrument, and although they can fall under URDG, it is more appropriate for a standby letter of credit to be issued subject to the ICC's Uniform Customs and Practice for Documentary Credits (UCP500), which specifically includes reference to these tools or under the International Stand-by Practices (ISP98), which came into force in 1999. ISP98 were developed for specific application to stand-by letters of credit because UCP500 contained several articles applicable to the general commercial letter of credit, which should, strictly speaking, be excluded each time UCP500 is expressed to apply to a stand-by letter of credit. ISP98 were drafted under the auspices of the Institute of International Banking Law & Practice Inc. and were approved by the ICC and published by them as publication No. 590. They were designed to be compatible with the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit.

This UN Convention came into force in January 2000. Although endorsed by the ICC, only about half a dozen countries have adopted it so far. The United States has signed it but not ratified it yet. The Convention is intended to provide a harmonized set of rules for the two types of instrument referred to in its title and to provide greater legal certainty in their use for day-to-day commercial transactions. In addition to being consistent with UCP and URDG and working in tandem with them, the Convention supplements their operation by dealing with issues beyond the scope of those rules, in particular regarding the question of fraudulent or abusive demands for payment and judicial remedies in such instances. There is also a difference in emphasis: only a Government can adopt the UN Convention for its country. The ICC Rules will apply only if expressly stated in the guarantee or stand-by letter of credit, whereas the UN Convention automatically applies to such documents issued from a country that has adopted the Convention unless expressly excluded from the document.

Eurodollars

Eurodollars are dollar deposit claims upon U.S. banks, deposited (transferred) in banks located outside the U.S., including foreign branches of U.S. banks, so that the funds do not physically leave the U.S. banks. These dollar deposit claims, in turn, may be re-deposited in other foreign banks, lent to business enterprises, invested, or retained to improve reserves or overall liquidity. This reflects (1) the acceptability of United States dollars as a key reserve currency and (2) the availability of United States dollars in Eurodollar form (a) when domestic monetary policies might make money extremely difficult to obtain and/or (b) when balance of payments restraints encourage use of Eurodollars.

The Eurodollar market is principally maintained by commercial banks in London, Paris, and other European cities, which are willing to accept such U.S., deposit claims as time deposits, or (since 1966) willing to accept them as time certificates of deposit in negotiable form. This market actually includes other currencies, so that it might be more properly referred to as the Eurocurrency market. Transactions in dollars, however, constitute about 75% of the volume of transactions, which take place in wholesale amounts on the order of $1 million to $5 million or more, with maturities from call basis to one year, although it is reported that maturities of up to 5 years or longer may be negotiated.

Eurodollar deposits are practically free of regulation by the host country, including U.S. regulatory agencies. For example, these are not subject to reserve requirements and FDIC fees. Regulation D requires that net domestic borrowings from the Eurodollar market be subject to a 3% domestic reserve requirement.

Negotiable Eurodollar CDs were designed by Citibank in London in 1966. They are usually sold in denominations larger than $250,000, although some are sold to smaller investors in certificates of $10,000 or more. Eurodollar CDs are not subject to a 3% reserve requirement and an FDIC fee of about 8 basis points, as are domestic CDs. Eurodollar CDs trade in secondary markets. Default risk and marketability depend on the issuing bank, so the market is usually limited to the largest banks with strong international reputations.

Markets also have developed for loans and deposits denominated in other currencies, such as the West German Mark, Swiss Franc, and Japanese Yen, but maintained outside these countries. These markets are referred to collectively as the Eurocurrency market.

Interest rates on Eurodollar deposits are usually higher than the rates paid on deposits in the United States, while Eurodollar market lending rates tend to be somewhat lower. Because Eurobanks operate with lower spreads than banks in the United States, they are able to compete effectively with domestic U.S. banks for loans and deposits. Their lower spread is possible because they do not have the additional costs associated with statutory reserve requirements, deposit insurance fees, and other regulatory constraints imposed on banks in the United States.

Eurodollars are, in essence, international money, and as such, they increase the efficiency of international trade and finance. As money, they provide an internationally accepted store of value, standard of value, and medium of exchange. Because Eurodollars eliminate the costs and risks associated with converting from one currency to another, they allow savers to scan the world more easily for the highest returns and borrowers to search out the lowest cost of funds. They are a worldwide link among various regional capital markets, helping to create a global market for capital.

Forfaiting

Forfaiting is derived from the French term "à forfait," which means "without recourse." Forfaiting is the discounting of Bills of Exchange or Promissory Notes or other evidence of debt without recourse to the party from whom the debt instrument is purchased. These debt instruments are due to mature in the future and arise from the provision of goods and services. The forfaiter buys Bills of Exchange or Promissory Notes from an exporter (seller) at a discount. The exporter (seller) receives immediate cash from the forfaiting institution. The forfaiting institution will collect from the importer (buyer) in the future. Forfaiting institutions may be subsidiaries of large international banks or companies specializing in international trade financing.

The transaction is usually arranged between the seller's and buyer's banks. The seller's bank, or forfaiting institution, takes over the right to the seller's Bills of Exchange or buyer's Promissory Notes. There are, therefore, four parties involved:

Exporter, seller, or supplier of the goods or services.
Importer, buyer, or purchaser of the goods or services.
Guarantor for the importer.
Forfaiter or forfaiting institution.

Because a forfaiter purchases debt instruments without recourse to the seller, he is bearing all the risks of non-payment by the importer (debtor). This is fundamental to forfaiting. Unless the importer (debtor) is a first-class company or institution of unquestionable ability to pay, the forfaiter will seek some security for the debt. This will take the form of an "Aval" or irrevocable and unconditional guarantee in a form and by a bank or state organization acceptable to the forfaiter. The Aval is an irrevocable and unconditional undertaking or commitment by the bank to pay the holder of the Bill of Exchange or Promissory Note (forfaiter) in the event that the importer (debtor) does not pay its financial obligation. This Aval will be the forfaiter's sole security for the debt. This security facilitates the resale of the discounted Bills of Exchange or Promissory Notes ("discounted paper") to other forfaiters. In order for the bank to issue its Aval, it will need to be able to assess the debtor's creditworthiness.

Forfaiting has been used in Europe for a long time, beginning with Finanz AG of Frankfurt, Germany, and Union Bank of Switzerland. It appeared in the United States and United Kingdom only in the 1980s. In 1988, it was estimated that about 1% of world trade, or approximately US$30 billion, was financed with forfaiting.

Forfaiting through a forfaiter involves the following steps:

The exporter (seller) makes a sale of goods or services to a foreign importer (buyer).
The exporter receives Bills of Exchange or Promissory Notes for future payment at a fixed rate.
The exporter sells the Bills of Exchange or Promissory Notes to its forfaiter (forfaiting institution or bank) at a discount from face value and receives immediate cash.
The forfaiter assumes full responsibility for collection.
The Bills of Exchange or Promissory Notes are guaranteed by the importer's forfaiting institution; the guarantee (Aval) is irrevocable and unconditional.
The importer pays for the purchase over time, usually 2-5 years, but up to 7 years or more. Forfaiting is considered to be medium-term, fixed rate, export financing.

Typical sales range from US$200,000 to US$5,000,000 and carry a fixed rate of interest. Forfaiting is used most frequently in transactions by capital goods manufacturers and distributors of commodities. The risk is borne by forfaiter, which is usually the exporter's bank.

The advantage of forfaiting to the exporter is the receipt of immediate payment for the discounted paper, while the advantage to the importer is extended payment terms. The popularity of forfaiting as an export financing mechanism is sensitive to interest rates. Rising interest rates discourage forfaiting.

Guaranty

A Guaranty is a contract or undertaking in which the guarantor (signor) engages that the promise of another shall be performed, usually the payment of a debt or the performance of a contract. A Guaranty is a contract in which a third party, the guarantor, intervenes in an agreement between two parties by becoming responsible to one for default of the other, the party for whom the guaranty is made being known as the guarantee.

There are two kinds of guaranties of debt - guaranty of payment and guaranty of collection. In the first case, the guarantor is in default the moment the debt is due and unpaid; in the second, the guarantor is in default only after the principal debtor has been sued and the creditor (guarantee) has employed every expedient to enforce payment.

When a bank issues a commercial (documentary) letter of credit, it requires the party for whom it is issued to sign a guaranty to pay all drafts issued thereunder and to be responsible for the validity, correctness, and genuineness of the supporting document.

Two forms of guaranty agreements are used in connection with bank loans - a continuing guaranty and specific guaranty. In the former, the guarantor is responsible for the default of the debtor for whom the guaranty is made, up to a certain limit so long as the agreement is in force., and may therefore cover all the loans of the debtor. In the latter, the guarantor holds itself responsible only for a particular described loan.

With respect to our Private Lending Services, the guarantor is responsible for making payment to the lender in the event of default by the borrower. This payment may comprise the loan principal amount and/or the interest due. The guaranty instrument may be a Standby Letter of Credit, Letter of Guarantee (to be issued by non-U.S. banks), Letter of Insurance Guarantee, Corporate Guarantee, Municipal Guarantee, or Sovereign Guarantee.

It should be noted that collateral, by itself, is not a guaranty. Collateral denotes a grouping of assets that are usually pledged to a commercial bank to secure a loan. These assets are segregated for possible liquidation by the bank into cash in the event of default by the borrower. Commercial banks require that applicants desiring the issuance of such guarantee instruments make direct pledges of acceptable collateral to secure the guarantor's issuance of the guaranty.

Letter of Credit

A Letter of Credit is an instrument by which a bank substitutes its own credit for that of an individual, firm, or corporation, to the end that domestic and foreign trade may be more safely, economically, and expeditiously conducted. A definition of "Letter of Credit" is as follows:

"A letter requesting one person to make advances to a third person on the credit of the writer is a letter of credit. These letters are general or special. They are general if directed to the writer's correspondents generally. They are special if addressed to some particular person."

From a functional standpoint, banks recognize two classes of letters of credit - commercial and traveler's - and the above definition includes both classes. A Commercial Letter of Credit has been defined as follows:

"An instrument by which a banker, for account of a buyer, gives formal evidence to a seller of its willingness to permit him to draw on certain terms and stipulates in legal form that all such bills will be honored, is what has come to be known as a commercial letter of credit" (Board of Governors of the Federal Reserve System, Federal Reserve Bulletin).

The following is a somewhat more complete definition:

"An instrument drawn by a bank, known as the credit-issuing bank (and eventually the drawee bank), in behalf of one of its customers (or in behalf of a customer of one of its domestic correspondents), known as the principal (who guarantees payment to the credit-issuing bank), authorizing another bank at home or abroad, known as the credit-notifying or negotiating bank (and usually the payer bank), to make payments or accept drafts drawn by a fourth party, known as the beneficiary, when such beneficiary has complied with the stipulations contained in the letter."

According to Interpretive Ruling 7.7016 of the Comptroller of the Currency, letters of credit should be issued in conformity with the following:

Each letter of credit should conspicuously state that it is a letter of credit or be conspicuously entitled as such.
The bank's undertaking should contain a specified expiration date or be for a definite term.
The bank's undertaking should be limited in amount.
The bank's obligation to pay should arise only upon the presentation of a draft or other documents as specified in the letter of credit, and the bank must not be called upon to determine questions of fact or law at issue between the account party and the beneficiary.
The bank's customer should have an unqualified obligation to reimburse the bank for payments made under the letter of credit.

Commercial letters of credit are classified as follows:

Direction of shipment.

Export.
Import.
Domestic.

Security.

Documentary.
Clean.

Tenor of drafts drawn thereunder.

Sight.
Time.

Form of letter.

Straight.
Revolving.

Form of currency.

Dollar.
Continental currency.
Asiatic currency.
Other currency.

Privilege of cancellation.

Irrevocable - confirmed.
Irrevocable - unconfirmed.
Revocable - unconfirmed.

Payment of principal.

Paid.
Guaranteed.

None of the above classification is mutually exclusive.

In issuing letters of credit, a bank is not called upon to part with cash unless it discounts acceptances drawn under the terms thereof. The liability created in the issued of letters of credit is not restricted, but the national banking laws and the Federal Reserve Act place definite limitations upon the amount which a member bank may accept under such credits.

From a review of legal decisions on commercial letters of credit, the following principles apply:

A letter of credit is not a negotiable instrument.
It does not create a trust fund in favor of the beneficiary.
An issuer of a letter of credit may not dishonor drafts presented by a negotiating bank under a clean irrevocable letter of credit if all the terms of the credit are fulfilled.
An issuer may dishonor bills drawn in violation of the conditions specified in a documentary letter of credit.
The negotiator is not liable for the genuineness of either goods or documents.
The issuer is responsible to the party requesting the credit for the observance of the conditions by the beneficiary.
The contract between the issuer and the beneficiary is entirely independent of the contract of sale between the buyer and seller, and the issuer cannot, because of the seller's breach of contract of sale, refuse to honor drafts that comply with the terms of the letter of credit.

Letter of Guarantee

A Letter of Guarantee is a separate document in which the guarantor commits to pay a series of Promissory Notes on the respective due dates. Like an Aval, a Letter of Guarantee must be abstract and, therefore, make no conditional reference to an underlying commercial contract. A Letter of Guarantee must be irrevocable and unconditional and be fully transferable, assignable, and divisible.

The term "Bank Guarantee" may be used to refer jointly to Standby Letters of Credit and Letters of Guarantee. There is, however, no document specifically called a "Bank Guarantee." In any event, Letters of Guarantee and/or Standby Letters of Credit are used to assure the repayment of Promissory Notes evidencing the indebtedness of a borrower to a lender. The effect of a Letter of Guarantee is the same as that of a Standby Letter of Credit, although United States banks are prohibited from issuing Letters of Guarantee. Only banks outside the U.S. are permitted to issue Letters of Guarantee in addition to Standby Letters of Credit. A Letter of Guarantee may be issued for a multi-year period, whereas a Standby Letter of Credit may be issued for only one year with possible issuance of a new Standby Letter of Credit for an additional one-year period. Capital Access Financial and its lenders will accept Letters of Guarantee and/or Standby Letters of Credit from approved foreign banks as well as Standby Letters of Credit from approved U.S. banks. As a practical matter, U.S. banks are somewhat hesitant to issue Standby Letters of Credit except for their most creditworthy and valued customers.

Letter of Insurance Guarantee

A Letter of Insurance Guarantee is a secured, insurance company corporate guarantee. It is not an insurance policy. An insurance policy is inherently conditional by virtue of the requirement for the payment of a premium: if the policyholder fails to pay the premium, then the policy will terminate. A Letter of Insurance Guaranty is similar to a Standby Letter of Credit and Letter of Guarantee insofar as it assures the repayment of Promissory Notes evidencing the indebtedness of a borrower to a lender, and it is an irrevocable and unconditional undertaking by the issuing insurance company.

As a practical matter, the issuers of these Letters tend to be large, international property and casualty insurance companies with headquarters (home) offices located outside the U.S. Due to U.S. insurance regulations pertaining to the issues of collateralization and capitalization of such guarantees, that are promulgated and administered by the States, most U.S. insurance companies are hesitant to issue Letters of Insurance Guarantee. Conversely, many international insurance companies are more willing to consider the issuance of these Letters, providing that the prospective borrower meets specified financial requirements.

In order to identify insurance companies that may be likely issuers of these Letters, a borrower is encouraged to consult the internationally recognized firm of A.M. Best. This firm evaluates insurance companies throughout the world and publishes various insurance company ratings and reports about the insurance companies it reviews. The directory entitled "Best's Insurance Reports® International" should be consulted for detailed rating and analytical information about prospective issuers. The firm of A.M. Best may be contacted as follows: A.M. Best Company, Oldwick, New Jersey 08858, Telephone 908.439.2200, Facsimile 908.439.3363

London Interbank Offered Rate (LIBOR)

The London Interbank Offered Rate is the interest rate on dollar-denominated deposits, also known as Eurodollars, traded between banks in London. A Eurodollar is a dollar deposited in a bank in a country where the currency is not the dollar. The Eurodollar market has been around for over 40 years and is a major component of the International Financial Market. London is the center of the Eurodollar market in terms of volume.

LIBOR is the base rate of interest at which banks offer to lend money to one another in the wholesale money markets of London. Money can be borrowed overnight or for a period of up to five years through our private lenders. A frequently quoted rate is for "three-month money". The three-month LIBOR tends to be used as a yardstick for many lenders involved in high-value transactions. Lenders quote rates as "points" or "margins" above LIBOR.

The Wall Street Journal and the Financial Times of London, among other prestigious financial periodical publications, provide daily quotations of LIBOR. The Wall Street Journal uses an average of the LIBOR's from five major banks, or "reference banks": Bank of America, Barclay's Bank PLC, Bank of Tokyo Mitsubishi, Deutsche Bank, and Union Bank of Switzerland. The Financial Times uses an average of the LIBOR's of four major reference banks: Deutsche Bank, Bank of Tokyo Mitsubishi, Barclay's Bank PLC, and National Westminster Bank. The banks comprising this group are regularly rotated with other major banks. Daily LIBOR quotations are available for overnight, one month, three months, six months, and one year. Quotations for two years, three years, four years, and five years are also available through private negotiation. These reference banks set the respective LIBOR rates each day at 11:00AM. These rates fluctuate throughout the trading session according to sentiment about the outlook for base interest rates. LIBOR is determined by the supply and demand for funds in the Euromarket locations for each currency.

The Euro lending rate has no name comparable to the United States Prime Rate; rather, it is determined as LIBOR plus a margin charged to the borrower. Banks generally do not require compensating balances or other implicit charges in addition to the margin over LIBOR in the Euromarket, which helps to reduce the borrower's cost of using the market. The level of LIBOR tends to be lower than the U.S. Prime Rate, which is the base interest rate that U.S. banks offer to their most creditworthy borrowing customers. Domestic banks in the United States must comply with Federal Reserve requirements that result in a higher cost of funds to U.S. banks. Eurodollar funds are not subject to these same Federal Reserve requirements. Banks also offer to borrow money in the wholesale money markets. The rate that banks borrow at is called the London Interbank Bid Rate or LIBID. For additional information, please visit www.bba.org.uk.

Margin over LIBOR

The margin is a percentage reflecting the lender's assessment of the guarantor's financial strength, reputation, risk of default on loan guarantees, and geo-political circumstances affecting the guarantor. It is essentially a premium that quantifies the amount of risk that the lender perceives to be prevalent with respect the quality of the guarantor's financial track record. In general, the lowest possible margin is .50% (50 basis points). This .50% margin is assessed to the largest and financially strongest commercial bank guarantors. Higher margins reflect the lender's perception of increasing levels of risk. Margins may fluctuate over time due to changes in the lender's assessment of potential risk. In general, strong guarantors have lower margins than weak guarantors.

Medium Term Notes (MTN)

Medium Term Notes are a form of collateral that a prospective borrower may arrange to directly pledge to a major bank to secure the bank's issuance of a Standby Letter of Credit, Letter of Guarantee, or Guarantee Par Aval of Promissory Notes.

The continuously offered MTN has been one of the fastest growing segments of the debt markets. From $800 million in 1981, worldwide MTN program volume exploded to over $350 billion in 1996.

MTNs are debt instruments issued in the same form but through a different mechanism than other types of corporate, financial institution, or government obligations. MTNs are offered continuously through agents or dealers on a best-efforts basis rather than on a firm commitment (underwritten) basis. The minimum transaction amount is typically $100,000.

Since its establishment in the early 1980s as a bridge over the funding gap between short-term commercial paper and long-term borrowings in the bond market, the MTN market has evolved to such an extent that the term "medium" is becoming a misnomer. While the vast majority of MTNs are issued in the short end of the maturity curve (2-5 years), MTN maturities in the 10 to 30 year range are becoming more commonplace.

The MTN market provides an investor with a broad range of investment-grade credits across all industry sectors including banks, corporations, finance companies, utilities, Federal, and provincial governments and their crown corporations. This feature offers an investor the opportunity to diversify risk.

By the very nature of the continuous-offering, investors have an infinite number of choices
with respect to the type of MTNs purchased, maturity dates, and dollar amounts. This provides the investor with the ability to fill portfolio gaps that traditional bonds may not meet.

The rapid growth of the MTN market has attracted the attention of a growing number of investment dealers, resulting in increased liquidity. In fact, the MTN market is as liquid as the traditional corporate bond market, thus providing investors with the ability to transact at very competitive spreads.

Because of the continuous-offering process, the MTN market gives the investor immediate
access to an almost unlimited array of fixed income securities in widely varying maturities
issued by a broad spectrum of issuers.

MTNs are offered by way of a Shelf Prospectus that has been filed with the various securities regulators. This filing is for a two-year term and permits the issuer to access the market at any time in response to particular investor requirements or market timing, structuring, or term opportunities.

In the beginning, MTNs were issued in some countries as an extension of commercial paper programs. In other words, they were stand alone "promises to pay" backed-up by the unsecured commitment of the issuer. As the MTN market continued to grow, however, issuers wishing to attract a larger investor base began adding the protective provision of a formal Trust Indenture. These Trust Indentures have enhanced investors' security by providing the same protection as traditional bonds.

In an attempt to deliver a cost effective product to investors, the MTN market utilizes the Canadian Depository for Securities (CDS) system. The CDS uses a computer-based system that provides an efficient method for delivery, payment of interest and principal, and change of ownership. This permits the issuance of smaller sized offerings that would otherwise be cost prohibitive.

The MTN may be viewed as a platform that permits the issuance of a wide and varied range of securities, the most popular of which is the Structured Note, which may be Callable Notes or Equity Linked notes. The rapid growth of Structured Notes has been in part a result of the development of the MTN market.

Promissory Note

As defined by the Negotiable Instruments Law under the Uniform Commercial Code (UCC), a Promissory Note is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand or at a fixed or determinable future time, a sum certain in money, to order or to bearer. Promissory Notes may be issued by individuals, partnerships, corporations, institutions, and governments.

One of the essential characteristics of Promissory Notes is negotiability. Negotiation is achieved by delivery or by endorsement. A Promissory Note will be non-negotiable if the words of negotiability, "bearer" or "order" are omitted from its face. Classified by methods of determining maturity, Promissory Notes are of two forms: (1) payable upon a specified date or (2) payable a certain number of days after a fixed date. The first is known as a "fixed date" note and the second as a "days after date" note.

A Promissory Note may be secured or unsecured with respect to a pledge of collateral by the maker of the Note. A secured Promissory Note evidences a financial obligation by the maker to a creditor or lender and pledges a specific assembly of collateral that may be seized by the creditor or lender for liquidation if the maker of the Note defaults on his obligation(s) under the Note. An unsecured Promissory Note does not include a pledge of collateral.

Promissory Notes will always be used to evidence the indebtedness of the borrower to our lenders. This Note must always be guaranteed with respect to the repayment of the loan principal amount and all due interest. The Note(s) must be guaranteed by a Standby Letter of Credit, Letter of Guarantee, Letter of Insurance Guarantee, Unsecured Corporate Guarantee, Municipal Guarantee, or Sovereign Guarantee. Within the context of forfaiting, a Promissory Note is the written promise by the importer (buyer) to pay the exporter (seller).

Standby Letter of Credit

A Standby Letter of Credit is a contractual arrangement, issued by a commercial bank, guaranteeing financial or economic performance involving three parties - the "issuer" (bank), the "account party" (the bank customer), and the "beneficiary." The bank guarantees that the account party will perform on a contract between the account party and the beneficiary. In essence, a Standby Letter of Credit is a bank promise to pay a specific sum of money to a named beneficiary in the future in the event of non-performance by the account party. The Standby Letter of Credit is payable upon presentation of evidence of default. A Standby Letter of Credit is not a negotiable instrument. That is, a Standby Credit cannot be purchased or sold. It must be applied for by the bank's customer, who is referred to as the "Applicant."

The effect is to substitute the bank's liability for the account party's liability. The account party compensates the bank for the risk. The Standby Letter of Credit contract typically includes provisions that allow the bank to (1) require the account party to deposit funds to cover anticipated payments the bank must make under the arrangement, (2) debit the account party's account to cover disbursements, (3) require collateral during the term of the arrangement, and (4) book any unreimbursed balance as a loan at interest and on terms set by the bank.

Typically, Standby Letters of Credit expire without being used. Banks that provide Standby Letters of Credit to customers generally have lending and deposit relationships with these customers. In the late 1980s, banks charged issuance fees for 1-year maturity Standby Letters of Credit, that ranged from .25% - .50% (25 to 50 basis points) on the face amount of the Letter of Credit. Fees on longer-term and lower-quality credits ranged from 1.25% - 1.50% (125 to 150 basis points) or more, depending on the risk. Currently, banks charge their best customers fees ranging from .50% - 1.00%, depending on the quality of the customer's banking relationship. Standby Credits, according to U.S. banking law, may be issued for only one year at a time with possible re-issuance for additional 1-year extensions. Standby Letters of Credit expire 15 days after the date of the beneficiary's draft and never expire after "one year and one day." Such language renders the instrument fraudulent.

Standby Letters of Credit are "off-balance sheet" items. That is, these credits are not booked as assets (loans) or liabilities (deposits) on the bank's Balance Sheet. These credits are recorded in the Footnotes section of the Balance Sheet as "Contingent Liabilities." Thus, a loan backed by a Standby Letter of Credit has no impact on the bank's Balance Sheet. In the event of non-performance, however, a Standby Credit becomes a direct liability or loan to the account party.

Interpretive Ruling 7.1160 of the Comptroller of the Currency defines the term "Standby Letter of Credit" to not include commercial letters of credit and similar instruments (1) wherein the issuing bank expects the beneficiary to draw upon the issuer, (2) which do not guarantee payments of a money obligation, and (3) which do not provide for payment in the event of default by the account party. This Ruling defines a Standby Letter of Credit as any letter of credit, or similar arrangement however named or described, which represents an obligation to the beneficiary on the part of the issuer (1) to repay money borrowed by or advanced to, or for the account of the account party, (2) to make payment on account of any indebtedness undertaken by the account party, or (3) to make payment on account of any default by the account party in the performance of an obligation. Standby Letters of Credit are subject to the limitations of 12 U.S.C. 84 and must be combined with any other non-excepted loans to the account party by the issuing bank for the purposes of applying the referenced Section 84.

In general, banks are willing to issue Standby Letters of Credit only for their best customers. The issuing bank will require its customer, the Applicant, to make a direct pledge of collateral to the bank to secure the issuance of the Standby Letter of Credit. In this respect, the bank will perform a formal credit analysis of the customer and the collateral pledged to determine that a sufficient level of unencumbered equity exists in the collateral to protect the bank in the event that the Standby Credit is drawn upon in the course of a default. Most major banks require that this collateral be in a relatively "liquid" form, such as bank certificates of deposit, money market accounts, marketable securities, and other cash equivalents. The nature and variety of acceptable forms of collateral, to secure the issuance of Standby Letters of Credit, will vary from one bank to another. Currently, many banks are hesitant to accept real estate equity as security for Standby Credits because real estate is typically "illiquid," the value of the property is subject to the vagaries and uncertainties of the appraisal process, and the inherent risk that the value of the underlying real estate may deteriorate due to adverse market conditions and become increasingly more unusable by the bank as cash collateral. Customers wishing to obtain Standby Credits should expect to secure these credits at a level of at least 100% of the face amount of the Standby Credit to be issued. Most banks will require "excess collateralization" to compensate for risk-based concerns, such as collateral quality and liquidity. Bank customers who have existing "lines of credit" may generally convert an unused portion(s) of the "line" into a Standby Letter of Credit for a fee.

Most United States banks prefer to avoid issuing Standby Letters of Credit. This results from accountability, audit, and supervisory rules, regulations, and associated pressures imposed by the various Federal and state bank regulatory agencies including the Federal Deposit Insurance Corporation (FDIC), Comptroller of the Currency, Federal Reserve System, and State Banking Departments. Experience has shown that the major foreign banks, particularly European and Asian banks, are more likely to be willing to issue Standby Letters of Credit for creditworthy customers that demonstrate excellent financial strength and superior track records.

SWIFT

SWIFT is an acronym for - Society for Worldwide Interbank Financial Telecommunication. It is the global provider of secure financial messaging services. Swift is a closed, private telecoms network whose subscribers are banks, merchant banks, securities houses and other qualified financial institutions. Banks send messages to one another, including electronic funds transfer (EFT) on the Swift system using formats known as MTs (Message Types) numbered from MT100 to MT999, each for a different purpose.