Definition
An aval is a guarantee provided by a third party, most frequently a bank, ensuring that the payment stipulated in a financial instrument, such as a bill of exchange or promissory note, will be honored. The third party, known as the avalor, underwrites the obligation, thus reducing the risk for the creditor and facilitating smoother financial transactions. This guarantee strengthens the credibility of the instrument and provides a form of credit enhancement.
Examples of Aval
Example 1: Bill of Exchange
A business issues a bill of exchange to a supplier, promising payment within 90 days. The business’s bank adds its aval to the bill, guaranteeing that the payment will be made even if the business defaults.
Example 2: Promissory Note
A company issues a promissory note to an investor, promising to pay back a loan amount after a certain period. The company’s bank provides an aval, assuring the investor that the payment will be made by the bank if the company fails to fulfill its obligation.
Frequently Asked Questions
What is the purpose of an aval?
An aval serves to reduce the risk associated with financial instruments such as bills of exchange and promissory notes. By involving a reputable third party, usually a bank, it provides assurance that the payment will be made, even if the original issuer defaults.
Who can provide an aval?
Typically, banks or other financial institutions provide aval guarantees. However, in some instances, other creditworthy entities may also act as avalors.
How does an aval differ from a surety?
While both serve as guarantees, an aval is specifically tied to the payment of financial instruments like bills of exchange or promissory notes. A surety, on the other hand, can apply to a broader range of obligations and contracts.
Is an aval legally binding?
Yes, an aval is legally binding. Once the aval is given, the avalor is committed to fulfilling the payment obligation if the primary party defaults.
What are the benefits of having an aval?
The primary benefits include reduced credit risk, enhanced credibility of the financial instrument, and increased confidence among creditors and investors.
Related Terms
- Bill of Exchange: A written order requiring one party to pay a specified sum of money to another party on demand or at a fixed future date.
- Promissory Note: A financial instrument in which the issuer promises in writing to pay a determinate sum of money to the payee either at a fixed or determinable future time.
- Surety: A person or entity that takes responsibility for another’s performance of an undertaking, typically fulfilling a contract or debt.
- Endorsement: The act of signing one’s name on the back of a financial instrument, usually as a means of negotiating it or assuming liability.
Online References
- Investopedia: Aval Definition
- Corporate Finance Institute: Bills of Exchange
- Treasury Today: The Promissory Note Explained
Suggested Books for Further Studies
- “International Trade and Finance: A Functional Analysis” by Prof. Elhanan Helpman
- “Understanding International Trade Law” by Stephen C. Schneider
- “Financial Instruments and Markets: A Casebook” by Nuno Cassola and Mina Drif
Accounting Basics: “Aval” Fundamentals Quiz
Thank you for exploring the essential aspects of aval in financial accounting and challenging yourself with our quiz!
