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
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.
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.
Related Terms
- 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
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