Question

In which of the following forms of export financing does a bank assume a financial obligation?

1) with an L/C but not a documentary collection.
2) with a documentary collection but not an L/C.
3) neither an L/C nor a documentary collection requires a bank to assume financial obligation.
4) with either an L/C or a collection letter
5) with both an L/C and a documentary collection.

Answer 1

The form of export financing in which a bank assumes a financial obligation is with a Letter of Credit (L/C), not with a documentary collection. Therefore, option 1 is the correct answer.

Step-by-step explanation:

In the context of export financing, the instrument where a bank assumes a financial obligation is known as a Letter of Credit (L/C). An L/C is a guarantee provided by a bank on behalf of the buyer to the seller. If the buyer is unable to make a payment on the purchase, the bank will cover the outstanding amount. This significantly reduces the risk for the seller as they are assured of payment, either from the buyer or the bank.

On the other hand, a documentary collection does not involve a bank assuming a direct financial obligation. Rather, it is a transaction whereby the exporter entrusts the handling of commercial and often financial documents to banks and gives the banks instructions concerning the release of these documents to the importer. While banks handle the documents, they do not guarantee payment like they would with an L/C. To directly answer the student's question, the form of export financing in which a bank assumes a financial obligation is: 1) with an L/C but not a documentary collection. Therefore, the correct option in the final answer is the first one.