Definition — what a banker’s acceptance (BA) is
– A banker’s acceptance is a short-term payment instrument in which a bank promises to pay a specified amount to the holder at a future date. It is a form of bill of exchange (a written order to pay) that carries the bank’s guarantee rather than depending solely on the original issuer’s credit.
– Because a bank stands behind the obligation, the holder of a BA has greater assurance of payment than with a plain corporate check or unsecured note.
When and why business use BAs
– Commonly used in cross-border trade: an importer can obtain a BA dated after goods are due to arrive, giving the exporter a payment instrument guaranteed by the bank and therefore acceptable before shipment.
– Firms also use BAs to finance short-term needs without a conventional loan; they can hold BAs to maturity or sell them in the money market before maturity.
Key characteristics (quick list)
– Short maturities: typically issued around 90 days before maturity; can range from 1 to 180 days.
– Issued at a discount to face value: investors pay less today and receive the full face amount at maturity.
– Tradable: BAs can be bought and sold in the secondary money market prior to maturity.
– Credit reliance: the market values a BA based primarily on the paying bank’s creditworthiness; stronger-rated banks produce safer, more liquid BAs.
How a banker’s acceptance works — step-by-step
1. Trade agreement: importer and exporter agree on sale terms.
2. Buyer requests a BA from its bank, which reviews the buyer’s credit and may require collateral or a deposit.
3. Bank “accepts” the draft: it signs the instrument promising to pay the holder on the maturity date.
4. Exporter receives the BA instead of immediate cash; exporter can:
– Hold it to maturity and collect face value from the bank.
– Sell it in the secondary market at a discount to receive cash earlier.
5. On maturity, the bank pays the holder; if the original buyer defaults, the bank must make good on the payment.
Advantages and disadvantages — concise
Advantages
– Payment assurance: exporter gets the bank’s promise rather than the buyer’s alone.
– Facilitates trade without prepayment by the buyer.
– Lower relative cost compared with some hedging or credit products.
– Tradable and liquid in active markets (subject to bank credit quality).
Disadvantages / risks
– Bank bears payment risk if buyer defaults; bank may demand collateral or high credit standards.
– Not all banks offer BAs; they require an established banking relationship.
– If market liquidity is limited or bank credit weakens, selling before maturity may incur a larger discount.
Is a BA a money market instrument?
– Yes. Banker’s acceptances are treated as money market instruments: short-term, liquid debt-like papers that often trade at a discount and are used by institutional investors and banks.
BA rate — what it means
– The BA rate refers to the market yield an investor would earn if they bought a BA today and held it to maturity. It depends on the discount at which the BA trades and the time remaining to maturity.
– Conventions for annualizing yields vary; money markets often use a 360-day year. Be explicit about the convention used in any calculation.
How a BA differs from commercial paper
– Banker’s acceptance: payment is guaranteed by a bank; typically issued to support a trade transaction and sold at a discount.
– Commercial paper: an unsecured promissory note issued directly by corporations; it pays interest or is issued at a discount and does not carry a bank guarantee. Maturities can be short (days) or somewhat longer, and the investor relies on the issuing company’s credit.
Checklist — before obtaining or accepting a BA
– Confirm the issuing bank offers BA facilities.
– Verify bank credit quality and any limits on BA size and currency.
– Agree the maturity date and confirm it fits the delivery/shipment schedule.
– Understand collateral requirements or deposits the bank will demand.
– Decide whether you intend to hold to maturity or sell in the secondary market.
– Clarify settlement and transfer procedures for secondary sales.
– Check regulatory or tax implications in the relevant jurisdictions.
Worked numeric example (discount pricing and annualized yield)
Assumptions
– Face value at maturity: $100,000
– Time to maturity: 90 days
– Market price today: $98,500
– Use a 360-day year for annualizing (common in money markets). Note: other conventions (365-day) produce slightly different annualized yields.
Step 1 — Dollar discount
– Discount = Face − Price = $100,000 − $98,500 = $1,500.
Step 2 — Simple holding-period return
– Return over 90 days = Discount / Price = $1,500 / $98,500 ≈ 0.01523 (or 1.523%).
Step 3 — Annualize (money-market convention, 360-day year)
– Annualized yield ≈ 0.01523 × (360 / 90) = 0.01523 × 4 = 0.0609 → 6.09% per annum.
Notes on the example
– The chosen annualization (360-day) is a convention; some analysts use 365 days. Also some market quotes use the discount basis = (Face − Price)/Face × (360/days), which slightly changes the numerical result. Always confirm which yield convention a counterparty uses.
Short history (brief)
– Bank
kers’ acceptances were invented in the 19th century to facilitate international trade by substituting a bank’s credit for that of an importer. Exporters accepted a time draft drawn on an importer’s bank; once the bank “accepted” the draft it committed to pay the face value at maturity. This made the paper more marketable and allowed merchants and banks to finance cross-border shipments before modern electronic settlement systems.
How they’re used today
– Trade finance: BAs remain a trade-finance tool where a seller wants to be paid immediately and the buyer (or buyer’s bank) provides payment assurance.
– Liquidity and short-term investing: Institutional investors (money market funds, corporate treasuries) buy BAs as short-term, low-risk holdings.
– Collateral and repo markets: BAs can be used as collateral in repurchase agreements (repos), providing temporary liquidity.
– Interest-rate and cash management: Corporates and banks use BAs to manage short-term funding needs and match cash flows.
Key pricing conventions (summary and worked example)
Two common ways to express BA yields produce slightly different numbers. Always confirm which convention a counterparty uses.
1) Discount (face-based) convention — often called the discount basis
Formula:
Discount rate d = (Face − Price) / Face × (360 / t)
Example (Face = $100,000; Price = $98,500; t = 90 days):
Discount = $1,500
d = ($1,500 / $100,000) × (360/90) = 0.015 × 4 = 0.06 → 6.00
2) Price-based (investment or money-market) convention — often called the money-market yield or investment yield
Formula: y = (Face − Price) / Price × (360 / t)
This expresses return relative to the purchase price (so it measures the investor’s yield on funds actually invested rather than on face value).
Worked example (same inputs: Face = $100,000; Price = $98,500; t = 90 days):
– Holding-period return = (Face − Price) / Price = $1,