What is a Bill of Exchange?
A bill of exchange is a written document from one party (the drawer) to another party (the drawee) to pay a specified sum of money at a certain time. The advantage of a bill of exchange is that it allows the person who owes the money (the debtor) to delay payment until they have the money available. However, this can be useful if the debtor expects to receive money from another source shortly. It can also be utilized as a form of collateral. This means that if the debtor does not pay the amount specified in the bill of exchange, the creditor can take possession of the bill and use it to obtain payment from a third party.
Issuing and Negotiating Bills of Exchange
When it comes to issuing and using bills of exchange, there are a few important steps and people involved. Let's break it down in easy-to-understand language:
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Creation:: The person who owes money (called the "drawer") creates a document called a bill of exchange. They write down who should receive the money (the "payee"), how much needs to be paid, and when it's due.
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Presentation: The bill is given to the person who needs to pay the money (called the "drawee"). The drawee can either agree to pay the amount on the due date (this is called "acceptance") or refuse to accept the bill.
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Endorsement: The person who should receive the money (the "payee") can endorse the bill, which means they can make it payable to someone else. They can either leave it blank so anyone can receive the money (this is called "bearer form"), or they can specify a particular person who should get the money (this is called "order form").
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Discounting: The payee has the option to get money before the bill's due date by selling it to a bank or financial institution at a discounted value. This is called "discounting," and it allows the payee to receive funds right away.
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Payment: When the due date arrives, the drawee is legally obliged to pay the money to the payee or anyone else who holds the bill at that time.
Different Types of Bills of Exchange
Trade, accommodation, and sight bills are the three different types of bills of exchange:
i) Trade bills: Trade bills are the most commonly used form of bill of exchange, predominantly in facilitating international trade transactions.
ii )Accommodation bills: Accommodation bills are less prevalent than trade bills. They are used when one party wants to help another party finance a purchase.
iii) Sight bills: Sight bills are similar to trade bills but mature much faster – usually within days or weeks. This type of bill is often employed for time-sensitive transactions, such as the purchase of raw materials that require prompt processing.
Advantages of a Bill of Exchange
The advantages of a bill of exchange are:
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Enhanced security for the recipient: It provides security for the person or organization to whom money is owed. This is because the bill of exchange can be used as collateral for a loan. If the borrower defaults on the loan, the lender can present the bill of exchange to the payer and receive payment.
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Facilitation of international trade: It can be used to finance international trade. This is because banks often accept bills of exchange as collateral for loans. This allows businesses to finance their imports and exports without utilizing their own capital.
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Hedging against currency risk: Bills of exchange can be used to hedge against currency risk. This is because businesses can buy bills of exchange denominated in foreign currencies and use them to offset any losses they incur if the currency's value falls.
Example of Bill of Exchange
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Company X purchases auto parts from Company Y for Rs.50,000. Company Y draws a bill of exchange and becomes the payer as well as the drawee in this case. The bill of exchange presents an obligation of Company X to pay Rs.50,000 to Company Y in 90 days. Company Y has to present the bill to Company X for payment after 90 days.