Bills of exchange are used in commerce, particularly international trade, by businesses and banks in countries as far-flung and diverse as the U.S., Morocco, and Australia.
Think of a bill of exchange as an invoice presented in exchange for goods or services. In international trade, the exporter, or seller, presents a bill of exchange to the buyer, or importer, who must sign the bill for it to be valid. The bill of exchange unconditionally requires the buyer to pay a certain amount either on receipt of the bill or at some specified date in the future. The buyer usually isn't required to pay interest on the debt, but if they are, the requirement must be stated on the bill.
Banks typically become third parties to bills of exchange to help guarantee payment or receipt of funds. This helps reduce any counterparty risk inherent to the transaction.
Bill of Exchange in International Trade
International trade presents unique risks that are not often present in domestic transactions, making bills of exchange useful and more common. There are several reasons for this, such as separate legal jurisdictions and lengthy transportation routes. Most of these trades require currency exchanges, making long-term trade arrangements sensitive to exchange-rate fluctuations. The timeframe between the issuance of a bill and its payment is known as usance and can vary between countries.
Traditionally, the exporter or the exporter's bank draws up the bill of exchange and submits the document through the importer's bank; the importer's bank offers a contingent guarantee on the transaction. If the importer dishonors the bill of exchange and fails to make the payment, the importer's bank makes the payment and then pursues its customer for reimbursem*nt.
Bill of Exchange vs. Promissory Note
Though both are used in trade to establish an obligation for a buyer to pay a seller, bills of exchange differ in a fundamental way from promissory notes. Unlike the bill of exchange, which is written by the creditor, a promissory note is issued by the debtor, promising to pay a certain amount of money.
Trading Bills of Exchange
Bills of exchange can be bought and sold in secondary markets, though this is primarily done by banks and other financial institutions. Normally, the bill is discounted or sold for an amount that is less than the face value, as the holder is looking to raise cash immediately rather than wait for the bill to mature. The difference between the discounted price and the face value is the buyer's profit for assuming the risk.
Like a bond, the discount tends to be greatest when the maturity date of the contract is furthest away. In the U.S., banks' buying and selling of bills of exchange is regulated by the Federal Reserve.
Bills of exchange do not trade on an exchange like stocks or bonds, and there is no electronic settlement system. In fact, a trade involves physically sending a bill of exchange from one party to the other, and the party selling the bill must endorse it on the back, much like a common check.
FAQs
A bill of exchange often includes three parties—the drawee is the party that pays the sum, the payee receives that sum, and the drawer is the one that obliges the drawee to pay the payee. A bill of exchange is used in international trade to help importers and exporters fulfill transactions.
Who uses bill of exchange? ›
Bills of exchange are used in commerce, particularly international trade, by businesses and banks in countries as far-flung and diverse as the U.S., Morocco, and Australia. Think of a bill of exchange as an invoice presented in exchange for goods or services.
Who draws a bill of exchange answer? ›
Drawer is the one who draws the bill of exchange, drawee is the person towards whom the bill of exchange is drawn and payee is the person who will be getting the payment from the bill of exchange.
Who is the person to whom a bill of exchange is made? ›
The payee is the person to whom payment has to be made. The payee may be the drawer himself or a third party.
Is bill of exchange used nowadays? ›
Although bills of exchange may not be the go-to tool for accounting and payment agreements today, they offer a few considerable benefits: They're legal and binding documents. Bills of exchange are recognized legal documents in many nations around the world. They provide security for all parties involved.
Who accepts the bill in bills of exchange? ›
A bill of exchange is generally drawn by the creditor upon his debtor. It has to be accepted by the drawee (debtor) or someone on his behalf. It is just a draft till its acceptance is made.
When were bills of exchange used? ›
The bill of exchange originated as a method of settling accounts in international trade. Arab merchants used a similar instrument as early as the 8th century ad, and the bill in its present form attained wide use during the 13th century among the Lombards of northern Italy, who carried on considerable foreign commerce.
Who are the parties to a bill of exchange? ›
The three parties to the bill of exchange are: Drawer (Also known as the maker of the bill of exchange) Drawee (Upon whom the bill of exchange is drawn) Payee (The drawer or a third person who will be receiving the payment)
Who endorses a bill of exchange? ›
Endorsem*nt of the bill of exchange refers to the situation when the drawer of the bill transfers the bill in favour of his creditor in order to clear his debts.
Who is the original party to a bill of exchange? ›
Another notable feature of a bill of exchange is that it features three parties, which are as follows: The drawer: the party who writes the bill and orders the money be paid. The drawee: the party who is required to pay. The payee: the party who is due to be paid.
The acceptor of a bill of exchange at or after maturity is liable to pay the amount thereof to the holder on demand. The liability of the acceptor of a bill or the maker of a note is absolute and unconditional but is subject to a contract to the contrary and may be excluded or modified by a collateral agreement.
Who is the maker of a bill of exchange or? ›
The maker of a bill of exchange or cheque is called the drawer "; the person thereby directed to pay is called the " drawee" .
Is the bill of exchange Act a law? ›
The Act was drafted by Sir Mackenzie Chalmers, who later drafted the Sale of Goods Act 1893 and the Marine Insurance Act 1906. An Act to codify the law relating to Bills of Exchange, Cheques, and Promissory Notes.
Who can use a bill of exchange? ›
A bill of exchange often includes three parties—the drawee is the party that pays the sum, the payee receives that sum, and the drawer is the one that obliges the drawee to pay the payee. A bill of exchange is used in international trade to help importers and exporters fulfill transactions.
What is real life example of bill of exchange? ›
A bill of exchange is of real use if it is accepted by the person directed to pay the amount. For example, X orders Y to pay ₹ 50,000 for 90 days after date and Y accepts this order by signing his name, then it will be a bill of exchange.
What banks accept bills of exchange? ›
Any member bank may accept drafts or bills of exchange drawn upon it having not more than three months' sight to run, exclusive of days of grace, drawn under regulations to be prescribed by the Board of Governors of the Federal Reserve System by banks or bankers in foreign countries or dependencies or insular ...
Who are the other parties to bill of exchange? ›
The three parties to the bill of exchange are: Drawer (Also known as the maker of the bill of exchange) Drawee (Upon whom the bill of exchange is drawn) Payee (The drawer or a third person who will be receiving the payment)
Who receives the payment of bills of exchange? ›
A bill of exchange transaction can involve up to three parties. The drawee is the party that pays the sum specified by the bill of exchange. The payee is the one who receives that sum. The drawer is the party that obliges the drawee to pay the payee.
