Lesson 4 of 5
A banker’s acceptance is a bill of exchange drawn to finance trade (exports and imports) and accepted by a bank as good for payment. Originally, such bills were all transaction specific. In other words, a specific cargo would be financed, typically by the exporter drawing a bill on the importer, and then offered to a bank to accept. The bank would place its stamp and authorized signatures on the bill and from then on it became, for all intents and purposes, paper with the risk and quality of the accepting bank.
The accepting bank may pass on its accepted bill to another bank which if it were of better quality than the original bank may also accept it-thus increasing the quality of the paper itself. The quality of the accepter of the paper is the guide to the rate of interest that the bill is likely to attract. The better the quality, the finer the rate.
A banker’s acceptance is drawn from a specific amount (originally the value of the cargo) and does not bear an interest coupon. Instead it is discounted. The methodology for such a discount is ‘straight discount’, normally, although some bills go through at ‘discount to yield’.
The best quality bills in the UK are eligible for re-discount at the Bank of England. Although bills may not necessarily be drawn to cover specific cargoes there usually has to be an underlying trade business that the Bank of England can recognize. However, in the United States BAs can be drawn for more flexible reasons such as the funding of stocks or work in progress.
Example
A bill f exchange has been drawn for GBP 1 million, payable on 14 September. N June 20 (86 days to maturity), the bill is presented to Sahara Bank, which discounts it a 8% and pays away GBP 981,150.68. This bill is ‘ineligible’, since Sahara bank is not a recognised market marker in BAs.
On June 22, Sahara Bank passes the bill to a UK discount house, which accepts the bill and discounts it at 7.25%. It pays away GBP 983315.07 to Sahara bank. The discount house’s acceptance of the bill gives it eligibility and the bill can now be traded at much finer rates.
On June 23, the discount house sells the acceptance to an investment bank at 7.125%. The discount house receives GBP 983,797.95.
The investing bank does not accept the bill, but simply buys it with the intention of holding t until maturity.
At maturity on September 14, the investing bank receives GBP 1 million on presentation of the bill.(In the event that the bill is not paid direct by the original ‘drawee’ the presenter would expect the discount to pay, and the discount house in turn would look to Sahara Bank to honour its acceptance.)