How can the seller mitigate the credit risk on the buyer under collection documents sent on acceptance? (A) By confirmation (B) By avalisation of Bill of Exchange (C) None of these (D) By obtaining advance payment
Answer (1)
When dealing with collection documents sent on acceptance, such as a Bill of Exchange, the seller faces the risk that the buyer may default on the payment upon acceptance of the documents. To mitigate this credit risk, the seller can take several actions:
By obtaining advance payment (D): This is the correct choice. Receiving an advance payment from the buyer reduces the seller's risk because part or all of the payment for the goods is made before the seller ships the goods or sends the collection documents. This ensures that the seller does not solely rely on the buyer's acceptance and commitment to pay at a later date.
Other potential methods (for context):
By confirmation: This typically involves a bank adding its guarantee to the buyer’s bank's credit, ensuring that the payment will be made. Confirmation is more relevant in scenarios involving letters of credit.
By avalisation of Bill of Exchange: Avalisation is when a financial institution (like a bank) provides an additional guarantee of payment on the Bill of Exchange. This can also minimize risk, but it's more about adding a layer of security rather than a direct mitigation like obtaining advance payment.
By securing an advance payment, the seller can greatly reduce or eliminate the credit risk associated with the buyer's acceptance of the collection documents. This assures that financial risk is minimized by obtaining funds upfront.
