Trade Acceptance
Definition
Trade Acceptance is a type of time draft that is guaranteed by a non-bank firm, which makes it unique compared to other types of acceptances. This financial instrument is sold in the secondary money market and represents a promise by the buyer of goods or services (the drawee) to pay the amount due at a future date. Compared to a banker’s acceptance, a trade acceptance carries higher risk because the guaranteeing entity is a non-bank firm which may have a lower credit rating than financial institutions.
Examples
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Goods Purchase Agreement: A small manufacturing company purchases raw materials from a supplier. Instead of paying upfront, the supplier issues a trade acceptance, agreeing that the payment for materials will be made 90 days after delivery. The manufacturing company guarantees the payment by accepting the draft, which is then sold as a trade acceptance in the secondary market.
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Service Contract: A consulting firm provides services to a client over a year-long contract. To facilitate deferred payments, the client issues trade acceptances every quarter, agreeing to pay the owed amount after 60 days. These quarterly trade acceptances are used by the consulting firm to manage cash flow by selling them on the secondary market at a discount.
FAQs
1. What is the difference between a trade acceptance and a banker’s acceptance?
Trade acceptance is guaranteed by a non-bank firm, while a banker’s acceptance is guaranteed by a bank. This makes banker’s acceptance generally less risky due to the bank’s typically higher credit rating.
2. How is a trade acceptance used in transactions?
A trade acceptance is used in transactions where the buyer needs more time to pay for goods or services. The seller issues the acceptance, which the buyer guarantees, signifying an agreement to pay the specified amount at a future date.
3. Can trade acceptances be sold in financial markets?
Yes, trade acceptances can be sold in the secondary money market, providing liquidity to the seller.
4. Why is a trade acceptance considered risky?
A trade acceptance is considered risky because it is guaranteed by a non-bank firm, which may not have as strong a credit standing as a bank.
5. How does a company benefit from issuing trade acceptances?
Companies can benefit by getting immediate liquidity from selling trade acceptances in the secondary market at a discount, improving their cash flow.
- Banker’s Acceptance: A time draft guaranteed by a bank, representing a promise of future payment, typically considered low-risk due to the bank’s guarantee.
- Time Draft: A financial instrument that stipulates a future date by which the drawee must pay the drawer.
- Secondary Money Market: A marketplace where financial instruments like trade acceptances and banker’s acceptances are bought and sold.
Online References
Suggested Books for Further Studies
- “Purchased Money Market Instruments: Loans, Acceptances, and Commercial Paper” by Harvey A. Poniachek
- “Financial Markets and Institutions” by Frederic S. Mishkin and Stanley G. Eakins
- “Fundamentals of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus
Fundamentals of Trade Acceptance: Finance Basics Quiz
### What is a trade acceptance?
- [ ] A loan from a bank.
- [x] A time draft guaranteed by a non-bank firm.
- [ ] A type of bond.
- [ ] A cash transaction.
> **Explanation:** A trade acceptance is a time draft that is guaranteed by a non-bank firm, indicating a promise to pay at a future date.
### Who guarantees a trade acceptance?
- [ ] A bank.
- [x] A non-bank firm.
- [ ] A government agency.
- [ ] An insurance company.
> **Explanation:** The guarantee in a trade acceptance is provided by a non-bank firm, which distinguishes it from a banker's acceptance.
### Why is a trade acceptance more risky than a banker's acceptance?
- [ ] It involves higher interest rates.
- [ ] It is not regulated by the government.
- [x] It is guaranteed by a non-bank firm, typically perceived as having lower creditworthiness than a bank.
- [ ] It is sold in the primary market.
> **Explanation:** A trade acceptance is considered riskier because it is guaranteed by a non-bank firm, which may not have as strong a credit rating as a bank.
### Where is a trade acceptance sold?
- [ ] Primary stock market.
- [ ] Real estate market.
- [x] Secondary money market.
- [ ] Foreign exchange market.
> **Explanation:** Trade acceptances are typically sold in the secondary money market, providing liquidity to the seller.
### Which of the following is a similar instrument to a trade acceptance but is considered less risky?
- [ ] Corporate bond.
- [ ] Personal loan.
- [ ] Government bond.
- [x] Banker's acceptance.
> **Explanation:** A banker's acceptance is similar to a trade acceptance but is less risky because it is guaranteed by a bank.
### What purpose does a trade acceptance serve in business transactions?
- [ ] Allows for immediate cash payment.
- [ ] Provides a guarantee to suppliers.
- [x] Facilitates deferred payment for goods or services.
- [ ] Lowers interest rates on loans.
> **Explanation:** A trade acceptance facilitates deferred payment for goods or services, enabling the buyer more time to pay while providing liquidity to the seller.
### What happens if the non-bank firm guaranteeing a trade acceptance defaults?
- [ ] The bank steps in to pay.
- [ ] The government provides compensation.
- [ ] The drawee is automatically cleared of the obligation.
- [x] The holder of the acceptance may suffer a financial loss.
> **Explanation:** If the non-bank firm guaranteeing the trade acceptance defaults, the holder may suffer a financial loss because the guarantor fails to fulfill the payment obligation.
### How can a seller benefit from using trade acceptances?
- [ ] Getting higher interest rates.
- [x] Improving cash flow by selling the acceptance in the secondary market.
- [ ] Reducing production costs.
- [ ] Avoiding taxes.
> **Explanation:** A seller can improve cash flow by selling the trade acceptance in the secondary market at a discount.
### What is the main reason for issuing a trade acceptance?
- [ ] To increase stock prices.
- [ ] To fulfill immediate cash requirements.
- [x] To allow deferred payment for the buyer while guaranteeing payment at a later date.
- [ ] To secure investment from foreign investors.
> **Explanation:** The main reason for issuing a trade acceptance is to allow deferred payment for the buyer while guaranteeing the seller will receive payment at a later date.
### In what kind of market can trade acceptances not be sold?
- [ ] Secondary money market.
- [ ] Over-the-counter market.
- [ ] Money market.
- [x] Primary stock market.
> **Explanation:** Trade acceptances cannot be sold in the primary stock market as they are typically negotiated in the secondary money market.
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