Introduction to Commodities Investing
February 12, 2025
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A bill of exchange is a promissory note that is usually issued by the buyer to the seller of goods in return for the goods. The seller would like to sell their goods for cash. However, in certain cases, the buyer may not have cash immediately at the moment. However, they may be confident in their ability to generate cash in the future. The seller may also believe the buyer’s claims and may be interested in selling the goods to them as long as they promise to pay in the future.
In such a situation, bills of exchange become the preferred financial instruments. This is because a bill of exchange is a legal promise made by the buyer to the seller. There is usually no collateral backing this promise. However, it is not merely a verbal promise. It is a contract which is enforceable in the court of law. In essence, a bill of exchange is a promissory note and the buyer is expected to make good on their word.
The bill of exchange creates value out of nothing. A piece of paper becomes a promissory note when the buyer signs it. Such a note can then be traded in the market as a security. In this article, we will look at the concept of bills of exchange in more detail.
In order to better understand bills of exchange, we must first understand how they arise in the ordinary course of business. This can be best explained by studying the lifecycle of a bill of exchange.
The drawee is expected to carefully inspect the bill of exchange to verify that it explicitly mentions the agreement. If the drawee finds the bill to be accurate, he signs it. This act of signing the bill of exchange is called the acceptance of the bill. This is the moment when a verbal promise has become a security that can be traded in the market.
In such scenarios discounting of bills of exchange is used. A bill of exchange can be sold to the bank. The bank will deduct a certain amount of interest. This is called the discount amount and the post-discount amount is then paid to the drawer. The bank will then have ownership of the bill and has the right to collect dues from the drawee. The discounting of bills may be with or without recourse. Therefore, depending on the terms, the bank may or may not be able to hold the drawer liable if the drawee does not pay up.
Also, since the bill of exchange is a marketable security, in case the bank does not want to hold the bill, it can simply rediscount it with another bank and move out of the transaction.
Banks are more than willing to lend against bills of exchange if the drawer and drawee are credible parties. This is because bills of exchange offer certain advantages. They are as follows:
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