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CS Professional · Strategic Management and Corporate Finance · Raising of Funds - Non Fund Based

Which feature distinguishes a letter of credit from a bank guarantee as a non-fund based instrument used by a company?

A letter of credit assures a supplier of payment by the issuing bank upon presentation of compliant documents, thus facilitating trade, whereas a bank guarantee assures the beneficiary of payment or performance if the applicant defaults. Both are non-fund based, involving a commitment rather than an immediate cash advance.

  1. AA letter of credit is used mainly to support payment to a supplier on delivery of stipulated documents, whereas a guarantee secures performance or payment if the applicant defaultsCorrect
  2. BA letter of credit requires the bank to subscribe to debentures of the applicant
  3. CA letter of credit is always a fund based facility
  4. DA bank guarantee is issued only in favour of the bank itself

Explanation

Under a letter of credit the issuing bank undertakes to pay the seller when compliant documents are presented, supporting trade payment. A guarantee is a promise to pay or perform if the applicant fails. Both are non-fund based, and neither involves subscription to debentures.

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