Bill of exchange definition
/What is a Bill of Exchange?
A bill of exchange is a binding agreement by one party to pay a fixed amount of cash to another party as of a predetermined date or on demand. Bills of exchange are primarily used in international trade. Their use has declined as other forms of payment have become more popular. There are three entities that may be involved with a bill of exchange transaction. They are as follows:
Drawee. This party pays the amount stated on the bill of exchange to the payee.
Drawer. This party requires the drawee to pay a third party (or the drawer can be paid by the drawee).
Payee. This party is paid the amount specified on the bill of exchange by the drawee.
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Information Included in a Bill of Exchange
A bill of exchange normally includes the following information:
Title. The term "bill of exchange" is noted on the face of the document.
Amount. The amount to be paid, expressed both numerically and written in text.
As of. The date on which the amount is to be paid. Can be stated as a certain number of days after an event, such as a shipment or receipt of a delivery.
Payee. States the name (and possibly the address) of the party to be paid.
Identification number. The bill should contain a unique identifying number.
Signature. The bill is signed by a person authorized to commit the drawee to pay the designated amount of funds.
Issuers of bills of exchange use their own formats, so there is some variation from the information just noted, as well as in the layout of the document.
Transferability of a Bill of Exchange
A bill of exchange is transferable, so the drawee may find itself paying an entirely different party than it initially agreed to pay. The payee can transfer the bill to another party by endorsing the back of the document.
Discounting a Bill of Exchange
A payee may sell a bill of exchange to another party for a discounted price in order to obtain funds prior to the payment date specified on the bill. The discount represents the interest cost associated with being paid early. Though uncommon, this is a useful approach when a payee is experiencing a short-term cash flow problem.
When Interest is Included in a Bill of Exchange
A bill of exchange does not usually include a requirement to pay interest. If interest is to be paid, then the percentage interest rate is stated on the document. If a bill does not pay interest, then it is effectively a post-dated check.
Bill of Exchange Risks
There are multiple risks associated with a bill of exchange, which include the following:
Default risk. The drawee (payer) may fail to honor the bill on the due date, resulting in non-payment for the drawer (payee).
Forgery risk. A bill may be forged or altered fraudulently, leading to legal disputes or financial loss.
Credit risk. If the bill is endorsed to third parties, there is a risk that prior parties in the chain may default or be financially unstable.
Exchange rate risk. In international transactions, currency value fluctuations between issuance and maturity can affect the bill's value.
Liquidity risk. The holder may face difficulty converting the bill into cash before maturity if there is no ready market or willing buyer.
Legal risk. Improper drafting or failure to meet legal requirements can render the bill invalid or unenforceable in court.
Terms Similar to Bill of Exchange
A bill of exchange issued by a person may be called a trade draft. If the document is issued by a bank, it may be called a bank draft.