CREDIT INSTRUMENTS

A credit instrument is a written instrument or evidence of the existence and nature of a credit contract. It is evidence of an obligation or a claim.

FEATURES OF A CREDIT INSTRUMENT:
1. It is a written evidence of the existence of an obligation on the part of the debtor, or a claim on the part of the creditor.

2. It shows the degree of risk that confronts the creditor with respect too the collection of the debt.

3. It shows the nature of the debtor-creditor relationship.

FUNCTIONS OF CREDIT INSTRUMENTS:

1. Written documents make claims enforceable. The credit instrument enables the creditor to hold the host instrument to collect from his debtor. The debtor on the other hand is protected of his rights with respect to the amount of the obligation, interest and maturity date.

2. Credit instruments facilitate exchange transactions. To increase volume production, producer's farmers, manufacture and merchants avail themselves credit both use of the proper credit instrument.

3. Credit instrument minimize disputes among the contracting parties. Such instruments define the extent of the obligations and claims of debtors and creditors. Once both parties are bound by the same instruments, future disputes are avoided.

4. Credit instrument facilitates production and consumption. Stocks and bonds certificates issued  by corporations that are engaged in production activities. Consumers avail themselves of the use of book accounts, installment and checks to fulfill their instrument.

TERMINOLOGIES OF CREDIT INSTRUMENTS:

NEGOTIATION - refers to the art of transferring a negotiable credit instrument from one person to another in such a way as to constitute the transferee the holder of the instrument.

HOLDER OF DUE COURSE - is the payee or endorsee of a bill of exchange or note who is in possession of that instrument of bearer thereof.

NEGOTIABILITY - is the quality possessed by a credit instrument of value that permits legal title to it, to be transferred to one person to another by mere delivery or endorsement.

The requisites are:

1. It must be in writing.

2. It must be signed by the maker or drawer.

3. It must contain an unconditional promise or order to pay a sum certain in money.

4. It must be payable on demand or at a fixed determinable time.

5. It must be payable to order or bearer.

6. Where the instrument is addressed to a drawee, he must be named therein or indicated with reasonable certainty.

ENDORSEMENT - is the signing usually at the back of a negotiable instrument in order to guarantee or establish transfer of legal title over property right.

1. Blank endorsement is the signing of the instrument without specifying the evidence.

2. Special endorsement is one where the endorser specifies the person to whom or to whose order the instrument is to be payable.

3. Restrictive endorsement is one where the transfer of the possession of an instrument is for a certain purpose such as:

     a. To prohibit further negotiation of the instrument

     b. To constitute the endorsee to be the agent of the endorser

     c. To vest the title in the endorsee in trust for or to the use of some other persons

4. Qualified endorsement is one that limits or qualifies the liability of the endorser, and is affected by writing the words "without recourse" or "at the risk of the endorser".
5. Unconditional endorsement is one where the payment of the instrument depends on the happening of condition specified on the instrument.

PRESENTMENT - is the act of offering at the proper time and place a note, a bill of exchange or the like for acceptance, payment or discharge of liability on any credit instrument.

DISHONOR - refers to the non-payment or non-acceptance of the credit instrument by the party on whom it is drawn.

PROTEST - is the file in writing if upon presentment, a credit instrument is dishonored.

ACCEPTANCE-SUPRA PROTEST - refers to an agreement to pay a protested note, draft or any other credit instrument by a person other than the debtor.

ACCOMMODATION PHASE -  refers to a promissory note that has been endorsed by one or more persons in order that one who originally made that the note may obtain credit at a financial institution, usually a bank.

PAYABLE TO BEARER - whom the instrument does not specify a person to whom payment is to be made or whom it is payable to CASH, any bearer of the instrument is entitled to receive payment thereof.

CLASSIFICATION OF CREDIT INSTRUMENTS:

A. As Acceptability (general/limited)

     1. Credit instruments of limited acceptability are those whose acceptance will depend on the credit standing of the issuer or maker.

     2. Credit instruments of general acceptability are those that pass from hand to hand without question as to their source and which, in effect possess the characteristics of money.

B. As to Form

     1. Promise to pay contains the promise of one person to pay another a certain sum of money on demand or at a future determinable time.

     2. Order to pay is the order of one person to a second person to pay a third person a certain sum of money on demand or a future determinable time.

C. As to Function

     1. Credit money emphasis its use as a medium of exchange.

     2. Commercial credit instruments emphasis those used to facilitate to the use of credit in short-term commercial pursuits.

     3. Investment credit instruments involve those used for long-term credit.

PROMISE TO PAY

     1. Open Book Account - gives the implied verbal promise of the debtor when he buys consumable goods on credit. The creditor enters this ledger to show the existence of the credit transaction.

Advantages:

     a. It is convenient.

     b. It is simple.

     c. The absence of legal evidence is an advantage to the debtor for he gives no written evidence for his debt, and stimulates sales on the part of the creditor.

     d. It may lead to prompt payments because debtors may take advantage of cash discounts granted by the creditors.

Disadvantages:

     a. It may lead to disputes and misunderstanding.

     b. Payment is dependent on the debtor's voluntary action.

     c. Since there is no written evidence the essentials of negotiability are lacking in this type credit instrument.

     2. Promissory note is an unconditional written promise of the maker to pay the bearer or order a ceratin sum of money of at a future determinable time.

Advantages:

     a. There is a tangible proof of the existence of the debt.

     b. There is fixed time for payment.

     c. Prompt payment can be expected rather than at the whim of the debtor.

     d. It commands a higher as an asset especially for seeking, financial assistance.

     e. It gives no opportunity to dispute the quality of goods purchased upon credit.

Disadvantages:

     a. The inflexibility of the promissory note and its convenience of the part of the debtor has limited its use.

     b. The debtor has no choice on whether to take advantage of cash discounts or not.

     3. Collateral Promissory Note. In Similar to the ordinary promissory note but a collateral promissory note is described on its face or on a separate document. It is more secure than an ordinary promissory note in that there is some property held on deposit to assure payment of the debt.

Characteristics:

     a. It contains the borrower's unconditional promise to pay the amount of the loan to the order of the lender at maturity.

     b. The description of the collateral pledge is written on its face or on a separate document.

     c. It contains a provision that the holder of the note has a lien to the extent of the borrower's liability on all securities and funds of the latter which are under the control of the holder of the note.

     d. It may provide that upon default of payment of the note and all other liabilities will become due and payable without demand or notice, thus giving the holder the right to dispose of the collateral.

     e. The holder is also given the right to transfer the note and pledge the collateral without the notice to the borrower.

     f. It may contain the provision, which would require the borrower to submit the additional collateral in case the value of that is already held by the creditor declines.

     4. Collateral Letter of Credit. It is a written promise on the part of the bank to other drafts against in or for its account, by a specified beneficiary or his order, under the specifications contained thereon.

Contents:

1. The maximum amount covered on it.

2. The length of time it will be in force that usually takes into account the period of shipment and the drawing of the drafts.

3. The documents that must be attached as well as the disposal of these so that payment may be made.

4. The quantity and quality of the merchandise to be shipped.

5. The instructions on how the drafts are to be drawn.

CLASSIFICATIONS OF LETTERS OF CREDIT:

          I. According to the method of transmission:

                a. Circular. A letter of credit is termed circular when the opening bank issues a letter addressed generally to person or companies indicating its intention to honor the drafts of the beneficiary under the terms specified therein.

                b. Specifically Advised. On the other hand, when the opening bank notifies the beneficiary directly or through a notifying bank (usually a correspondent bank), the letter of credit is known specially advised.

         II. According to the duration of the substitution of credit:

                a. Revocable. Whenever the bank reserves the right to withdraw or modify the credit substantial for the buyer by such phrases as "good until cancelled" or "good until..."

                b. Irrevocable. When the bank waives its right to cancel the credit or revoke the same prior to the date specified. It has a binding effect since it cannot be revoked as long as the exporter fulfills his part of the conditions specified in the letter of credit.

        III. According to obligations assumed by the bank:

                a. Confirmed. When the notifying or advising bank, bank upon instructions of the opening bank, assumes the obligation to perform the undertaking stipulated in the letter of credit.

                b. Unconfirmed. When the advertising bank does not assume any other obligation except that of notifying the beneficiary.

       IV. According to the method of reimbursement:

                a. Simple. When the opening bank carries an account in the currency to paid with the paying bank, the reimbursement is simply done by book entries including service charge.

                b. Reimbursement. When the paying bank prefers to receives the reimbursement by draft, or when the two banks have no inter-bank accounts.

       V. According to the method of payment:

                a. Negotiation. If it is a circular letter of credit, payment is termed as negotiation.

                b. Straight. If it is specially advised.

                c. Sight. If payments are to be made with sight or demand drafts.

                d. Acceptance. If payments are to be effected with the time drafts are paid in the currency of the seller.

                e. Foreign currency. If the payment should be made in foreign currency, whether that of the buyer's or not.

ORDERS TO PAY

     The orders to pay used in the commercial activities may come in the form of checks, drafts, or acceptances.

A. Checks - Generally, it is an order of a depositor to his bank to pay a certain amount of money to a third party of himself on demand.

Types of Checks

1. Personal Check - sometimes known as a business check, and has the same definition as the check in general.

2. Cashier's/Manager's/Treasurer's - is one drawn by the cashier or treasurer or manager of the bank upon itself in favor of a third person.

3. Certified check - to enhance its acceptability, as the owner's credit worthiness may be doubted, the bank's certification is required by the recipient of the check. The check is then brought to the bank and the  authorized representative, after checking the depositor's ledger, writes/stamps the word "CERTIFIED" followed by his signature and date of certification across the face of the check.

4. Traveler's check - used by the traveler's. Its form is different in that it comes in convenient sizes and denominations in dollar.

5. Crossed check - such check has to be deposited to the account of the payee in his bank. It may easily be recognized and distinguished by the presence of the two parallel lines appearing in the upper left hand corner of the check.

6. Post-dated-check - one issued by the drawer showing future date.

7. State check - one which has not been cashed six months after the date of issue.

8. Rubber or bouncing check - when the check is returned to the drawer.

9. Cancelled check - when the depositor's checks are finally cleared and paid by his bank.

Advantages of checks

1. A check facilitates payments since exact amounts can be written on it face. Thus, there is no need of splitting money into different denominations, large or small. Therefore, it is convenient medium of exchange.

2. The check serves as a receipt for payment.

3. The check is more portable than even money itself.

4. It is safer to use on certain occasions.

5. Payment can be recalled if necessary. Because of the stop payment order, one can recall or cancel payment if he is not satisfied the merchandise or if delivery is delayed.

6. The use of checks affords the owner bank accommodations, such as facilitating payment of out-of-town checks or perhaps the facility of getting a loan.

Disadvantages:

            Checks owners must necessarily be very careful in issuing or handling their checks. Failure too do so cause either embarrassment of their part or loss of money. If one is not careful in keeping the stabs up-to-date, he might issue a bouncing check. The signature on the checks can also be forged or alterations can be made as to amount, date and payee.

B. DRAFTS - are orders to pay and are likewise drawn against a drawee to pay a third person a certain sum of money on demand or at a fixed determinable time.

TYPES OF DRAFTS

1. Money Order - may either be a bank order or a postal money order. When the order is drawn by a bank on another bank or the branch to pay a specified payee, then it is a bank money order. When the order is from one post office to another, then it is a postal money order.

2. Bank Draft - is an order to pay when the bank orders another bank or the depositor to his bank to pay a third person a definite sum of money, payable on demand or at a future determinable time.

3. Trade or Commercial Draft - used by merchants and may also be a demand or time draft.

4. Sight or Demand Draft - when the order to pay is payable at sight upon presentation.

5. Time Draft - when the order to pay sets a definite determinable future time of payment.

C. ACCEPTANCE - an acceptance is originally an order to pay. It is a time draft. To make sure of its payment at maturity, the draft is presented for acceptance to the drawee. If the drawee accepts, he becomes liable for the draft and in effect assumes the burden of payment at maturity.

TYPES OF ACCEPTANCES

1. Trade Acceptance - arise when the purchaser or importer of the goods accepts his obligations to the seller or exporter by writing the word "accepted" on the face of the draft.

2. Banker's Acceptance - when the order to pay is presented to a bank for its acceptance and the bank accepts the terms thereon, the bank's representative stamps the word "accepted" on the face of the draft.

Advantages of drafts and acceptances

      Since these are written instruments. They likewise provide evidence of the existence of debt. A draft in bank usage also has the advantages of the check. A commercial draft is advantageous because it serves as a collection device. In foreign trade the use of drafts serves to facilitate and thus enhances the flow of goods from one country to another. Acceptance for their part, have the advantages of both orders to pay and promise to pay.

Disadvantages

      In the case of acceptances, there is a danger of overtrading. It can also lead to lax credit investigation, for the seller will largely depend on the purchaser's promise to pay.