TYPES OF CREDIT

INSTRUMENTS AND ITS

FEATURES






By students of
Department of B.B.A,
Indus institute of higher education
(KARACHI)



INTRODUCTION: Credit or loan is the act of giving money, property or
other material goods to another party in exchange for future repayment of
the principal amount along with interest or other finance charges. A loan
may be for a specific, one-time amount or can be available as open-ended
credit up to a specified ceiling amount.
"Credit instruments are items that are utilized in the place of currency. Just
about all individuals and businesses make use of some type of credit
instrument on a daily basis. The ability to use a credit instrument instead of
currency rests in the fact that debtor and the recipient agree upon the use of
the instrument and there is a reasonable expectation that the alternate form
of payment will be honored.
The contractual amount of credit instruments represents the maximum
undiscounted potential credit risk if the counterparty does not perform
according to the terms of the contract, before possible recoveries under
recourse and collateral provisions. A large majority of these commitments
expire without being drawn upon. The credit instruments are issued by the
lenders only to those parties that are creditworthy. Credit risk for other
credit instruments using the same credit risk process that is applied to loans
and other credit assets.
The terms of a standardized loan are formally presented (usually in writing)
to each party in the transaction before any money or property changes
hands. If a lender requires any collateral, this will be stipulated in the loan
documents as well. Most loans also have legal stipulations regarding the
maximum amount of interest that can be charged, as well as other
covenants such as the length of time before repayment is required.
Some credit instruments like credit derivatives are used for the risk-
mitigation purposes. These instruments help the lending firm to manage the
credit risk associated with borrower.
Common types of credit instruments

The vast majority of credit instruments involve a mixture of standard types.
We can broadly classify the credit instruments used by the lender as follows-
O Credit instruments which are used for meeting working capital
requirements
O Credit instruments used for meeting capital expenditure
O egotiable instruments like bill of exchange
O on-funded credit instruments like L/C and B.G.
O Credit derivatives for risk mitigation
O ther instruments


orking Capital

The credit for fulfilling working capital requirements is usually given by using
following modes of credit like cash credit, WCDL, overdraft like bills of
exchange and commercial paper. Bill of exchanges are discussed under
negotiable instruments.
The security offered for working capital finance is current assets like
inventory, book debts and receivables.

CASH CREDIT
It is the most popular method to finance working capital requirements of a
company in India. Under the cash credit facility, a borrower is allowed to
withdraw funds from the bank up to the sanctioned credit limit. He is not
required to borrow entire sanctioned credit once, rather, he can withdraw
periodically to the extent of his requirements and repay by depositing
surplus funds in his cash credit account. There is no commitment charge;
therefore, interest is payable on the amount actually utilised by the
borrower. Cash credit limits are sanctioned against the security of current
assets such as inventory, receivables and debtors. Though funds borrowed
are repayable on demand, banks usually do not recall such advances unless
they are compelled by the adverse circumstances. Cash credit is the most
flexible arrangement from the borrowers point of view.

ORKING CAPITAL DEMAND LOAN
A borrower may sometimes require ad hoc or temporary accommodation in
excess of the sanctioned credit limit to meet unforeseen contingencies.
Banks provide such accommodation through a demand loan account or a
separate non-operable cash credit account. Such a loan is termed as working
capital demand loan. The borrower is required to pay a higher rate of
interest above the normal rate on such additional credit.

OVERDRAFT
It is similar to cash credit arrangement. Under the overdraft facility, the
borrower is allowed to withdraw funds in excess of the balance in his current
account up to a certain specified limit during a stipulated period. Though
overdrawn amount is repayable on demand, they generally continue for a
long period by annual renewals of the limit. It is very flexible arrangement
from the borrowers point of view sine he can withdraw and repay funds
when ever he desires within the overall stipulations. Interest is charged on
daily balances, on the amount actually withdrawn, subject to some minimum
charges. The borrower operates this facility through cheques.

COMMERCIAL PAPER
Commercial paper (CP) is an important money market instrument to raise
short term funds. CP is a form of unsecured promissory note issued by the
firms to raise short term funds. nly financially sound and highest rated
companies are able to issue commercial papers. The buyers of commercial
paper includes banks, insurance companies, mutual funds, trusts and firms
with short surplus funds to invest for a short period with minimum risk.
Given this investment objective demand for CPs of highly creditworthy
companies will always be there.

In India, RBI regulates issue of CPs. nly those companies which have a net
worth of minimum Rs. 10 crores, MPBF of not less than Rs. 25 crores and
which are listed on stock exchange are allowed to issue CPs. The size of the
issue should be at least Rs. 25 lacs and size of the each CP should not be
less than Rs. 5 lacs. A company can issue CPs amounting up to 75% of the
MPBF. The maturity of CPs in India usually runs between 91 to 180 days.

Interest rate on commercial paper is generally less than bank borrowing
rate. A firm does not pay interest on a CP but it sells it at a discounted
value. The yield calculated o this basis is referred to as interest yield which
can be calculated as,

Interest yield = (face value) - (sale price) * _____360_____
Sale price days of maturity

Interest on CP is tax deductible. In India, cost of a CP usually includes
discount, rating charges, stamp duty and issuing & paying agent (IPA)
charges.




Credit instruments used to meet capital expenditure

TERM LOAN
A loan from a bank for a specific amount that has a specified repayment
schedule and a floating interest rate is called as term loan.
A term loan (TL) is a credit contract in which the borrower receives funds
from the creditor(s) at contract closing or usually over a short period
following closing and, in return, agrees to make payments of interest, fees
and principal based on formulas and schedules specified in the agreement.
ften term loan is given to purchase fixed assets such as plant & machinery,
consumer products and house.
Term loans almost always mature between 1-10 years. But term loans like
home loans may be of maturity up to 20 years.
This kind of loan is preferred by many bankers because usually an asset is
created through this type of credit. Such asset provides security to the
banker.
Term loans are always secured in nature. The assets created from the term
loan, are charged to the bank and are a primary security. In case of loans
where no asset is created like in case of personal loan; collateral is required.
Borrowers also prefer term loans for capital expenditure as they are less
costly than other sources of finance like equity and interest on the term
loans is tax deductible.
Term loans can be quite complicated, involving amortization of principal,
differing levels of seniority, posting of collateral, detailed covenant
restrictions, prepayment penalties and interest and fees that may vary with
the borrowers risk rating or financial performance.

LOAN SYNDICATION/ CONSORTIUM ADVANCE/ MULTIPLE BANKING
ARRANGEMENT
Loan syndication is the process of involving several different lenders in
providing various portions of a loan.
It is mainly used in extremely large loan situations; syndication allows any
one lender to provide a large loan while maintaining a more prudent and
manageable credit exposure because the lender isn't the only creditor.
A syndicated loan (or consortium advance or multiple banking
arrangements) is a large loan in which a group of banks provide funds for a
borrower, usually several but without joint liability. There is usually a lead
bank or group of banks (the "Arranger/s" or "Agent/s") that takes a
percentage of the loan and syndicates or sells the rest to other banks. In
contrast, a bilateral loan, only involves one borrower and one lender (often a
bank or financial institution.) A syndicated loan is a much larger and more
complicated version of a participation loan. There are typically more than
two banks involved in syndication.
Syndicated loans can be underwritten or arranged on a best endeavors
basis. Where a loan is underwritten the Arrangers or Agents guarantee the
terms and conditions and costs of the loan before it is sold to other banks,
essentially removing the market risk for the Borrower.

BOND/ DEBENTURE
A corporate bond or a debenture is a credit instrument in which the issuer
obtains cash from the initial investors at origination and, in return, agrees to
make payments of interest and, at maturity, of principal to holders of the
securities. A bond or debenture is a long-term, fixed-income, financial
security. Debenture holders are creditors or lenders to the firm.
Bonds are less costly to the firm than equity because investors consider
them a less risky alternative and interest payments on bonds are tax
deductible.
There is no ownership dilution as bond holders do not voting rights. Bond
holders receive interest at a predetermined rate. Also during high inflation
period bond issue benefits the borrowing firm.
From the creditors point of view it is a secure credit as bonds are usually
secured in nature i.e. they can take control over the assets of the company
in case of default. Also when the borrowing firm is liquidated bondholders
have preference over shareholders of the borrowing firm.
Some bonds include sinking fund or redemption provisions basically
equivalent to amortization of principal. Most allow prepayment after a period
of call protection. The bonds comparative simplicity makes it more readily
marketable than other credit agreements that, in contrast, often include
clauses proscribing or limiting assignments.
But issuing firm has the legal obligation of paying interest & principal on due
date. Also it increases financial leverage of the firm and disadvantageous to
the firms with fluctuating sales and earnings.



Modes of Charge

Most credit facilities are secured in nature i.e. some assets of the borrowing
firm are charged to the lender/ bank. So it will be important to know various
types of charges that can be laid on the assets by the lenders while granting
the credit to the borrower.
O Lien
Lien is the right to retain securities/goods belonging to another, until a debt
due from the latter is paid.
O Set off
It is in effect the combining of the accounts of the debtor and creditor, so as
to arrive at the net balance payable to one or the other.
O Pledge
Pledge is bailment or delivery of goods as security for payment of a debt or
performance of a promise, as per section 172 of PAKISTA Contract Act,
1872. Goods are in the possession of the Bank. It is not a popular form of
security.
O Hypothecation
When the possession of the property in the goods and other movables
offered as security remains with the borrower and only an equitable charge
is created in favour of the lender, the transaction is called a hypothecation.
This is the most popular method of creating security for banks.
O Mortgage
Mortgage is the transfer of an interest in specific immovable property for the
purpose of securing the payment of money advanced by way of loan, an
existing or future debt or performance of an engagement, which may give
rise to a pecuniary liability.
As per sec 58 of transfer of property act 1882 the important types of
mortgage are:
Equitable mortgage
Registered mortgage or English mortgage
O Assignment
Actionable claims are assigned by the borrowers to the bank.
A borrower can assign Book debts Life Insurance Policies Money due from
Govt departments or Semi-govt organisations.



Negotiable instruments

PROMISSORY NOTE
A promissory note, also referred to as a note payable in accounting, is a
contract where one party (the maker or issuer) makes an unconditional
promise in writing to pay a sum of money to the other (the payee), either at
a fixed or determinable future time or on demand of the payee, under
specific terms. They differ from IUs (I owe unto) in that they contain a
specific promise to pay, rather than simply acknowledging that a debt exists.
The terms of a note typically include the principal amount, the interest rate if
any, and the maturity date. Sometimes there will be provisions concerning
the payee's rights in the event of a default, which may include foreclosure of
the maker's assets.
Demand promissory notes are notes that do not carry a specific maturity
date, but are due on demand of the lender. Usually the lender will only give
the borrower a few days notice before the payment is due.
For loans between individuals, writing and signing a promissory note is often
considered a good idea for tax and recordkeeping reasons. In the United
States, a promissory note that meets certain conditions is a negotiable
instrument governed by Article 3 of the Uniform Commercial Code.



egotiable promissory notes are used extensively in combination with
mortgages in the financing of real estate transactions. ther uses of
promissory notes include the capitalization of corporate finances through the
issuance and transfer of commercial paper.
At various times in history, promissory notes have acted as a form of
privately issued currency. In many jurisdictions today, bearer negotiable
promissory notes are illegal precisely because they can act as an alternative
currency. All Scottish and orthern Irish banknotes are effectively
standardized demand promissory notes.

BILL OF EXCHANGE
A bill of exchange or "Draft" is a written order by the drawer to the drawee
to pay money to the payee. The most common type of bill of exchange is the
cheque, which is defined as a bill of exchange drawn on a banker and
payable on demand.
Bill of exchange is most popular instrument of payment in financing the
internal and foreign trade in PAKISTA. Funds lent under BP/BD are
recoverable/ receivable after short period of time. Banks provide credit
facilities against such bills of exchange in following ways, when banks,
O egotiate such bills payable on demand/ against acceptance
O Purchases bills payable on demand
O Discount bills drawn on DA basis
O Grant advances against supply bills under collection

In the first 3 cases Bank becomes holder in due course for full value of bills
and in the fourth case it is holder in due course for value up to the advances
granted against such bills.
Bills of exchange are written orders by one person to his bank to pay the
bearer a specific sum on a specific date sometime in the future.
When bills are `purchased, such bills are payable on demand. When bills are
`discounted, such bills are payable after some usance period.
Banks collect commission and interest on the day of purchase/discount, the
advance sanctioned results into higher yield. The effective rate of interest is
more than what bank earns under Cash Credit or Term Loan.

Types of bills:
Bills to be purchased/ discounted could be documentary or clean and
demand or usance. When the instrument (bill) is accompanied by document
of title of goods (such as bill of lading, railway receipt, motor receipt etc.) it
is documentary bill and when no such documents of title to the goods
accompany the bill, it is a clean bill. However when documents of title to
goods are delivered against acceptance of a bill, the documentary usance bill
gets converted into a clean bill.

An example of bill of exchange







Transaction Process






CHEQUE
A cheque is an unconditional order, drawn on a specified banker and is
payable on demand.
Cheque is one of the earliest forms of a credit instrument. It is utilized by
consumers as a legitimate means of paying for goods and services received;
the value of the cheque is underwritten by funds that are placed in a bank
account. Upon the presentation by the recipient of the credit instrument, the
bank deducts the specified amount as recorded on the cheque by the debtor.
While the cheque is no longer the main credit instrument employed in many
financial transactions, it remains in use by many businesses and individuals.

General crossing
Where a cheque bears across its face an addition of the words `and co or
any abbreviation thereof, between two parallel transverse lines simply,
either with or without the words` not negotiable, that addition shall be
deemed a crossing and the cheque shall be deemed to be crossed generally.

Special crossing
Where a cheque bears across its face an addition of the name of a banker,
either with or without the words `not negotiable, that addition shall be
deemed a crossing and the cheque shall be deemed to be crossed specially
and to be crossed to that banker.

Not negotiable crossing
A person taking a cheque crossed generally or specially, bearing in either
case the words `not negotiable shall not have and shall not be capable of
giving a better title to the cheque than that which the person from whom he
took it had.

Payment of cheques

Where a cheque is crossed generally, the banker on whom it is drawn shall
not pay it otherwise than to a banker and where a cheque is crossed
specially, the banker on whom it is drawn shall not pay it otherwise than to
the banker to whom it is crossed or his agent for collection.

Different types of Payment of Cheques
Following are the various types of payment of cheques.
O Ante dated
O Post dated
O Stale cheques
O Amount in words and figures differs (sec 18 of I Act) )
O Authentication of alterations
O Forgery of drawers signature
O Payment during banking hours
O Protection to paying banker - 85(1) order cheques, 85(2) bearer
cheques

Refusal of payment of cheques
A banker can refuse to pay to the drawee against the cheque in following
conditions-
O Payment countermanded by the drawer
O Death of the drawer
O Insolvency of the drawer
O Insanity of the drawer
O Garnishee order
O Breach of trust - trust accounts
O Defective title of the property
O Mutilated cheques



Non-funded credit instruments

LETTER OF CREDIT
In a financial letter of credit (LC), the creditor guarantees the repayment of
counterpartys obligation and, in return, receives a one-time or periodic fee.
Thus, a bank could issue a financial LC in support of a customer obtaining
short-term cash from a money market fund that offers an attractive rate. In
a financial LC, the bank essentially provides credit insurance. The
instruments contingent pay-offs mirror those of a credit default swap.
A Letter of Credit (LC) is a letter from a bank guaranteeing that a buyer's
payment to a seller will be received on time and for the correct amount. In
the event that the buyer is unable to make payment on the purchase, the
bank is required to cover the full or remaining amount of the purchase. A
letter of credit is often abbreviated as LC or LC, and is also referred to as a
documentary credit.
The parties to a letter of credit are usually an applicant who wants to send
money, a beneficiary who will receive the money, the issuing bank and the
advising bank.
Letters of credit are often used for international transactions to ensure that
payment will be received. They have become an important aspect of
international trade, due to differing laws in each country and the difficulty of
knowing each party personally.
The bank also acts on behalf of the buyer, or holder of the letter of credit, by
ensuring that the supplier will not be paid until the bank receives
confirmation that the goods have been shipped.
A letter of credit is often confused with a bank guarantee, which is similar in
many ways but not the same thing. The main difference is the bank's
position relative to the buyer and seller of a good or service in the event of
the buyer's default of payment. With a letter of credit, a seller may request
that a buyer provide them with a letter obtained from a bank which
substitutes the bank's credit for their client's.
In the event of the borrower defaulting, the seller can go to the buyer's bank
for the payment. Instead of the risk that the buyer will not pay, the seller
only faces the risk that the bank will be unable to pay, which is unlikely. This
means that if the applicant obtaining the letter of credit fails to perform his
or her obligations, the bank must pay.
The letter of credit can also be the source of payment for a transaction,
meaning that an exporter will get paid by redeeming the letter of credit. A
letter of credit is less risky for the merchant, but even riskier for a bank.


BANK GUARANTEE
"A contract to perform the promise or discharge the liability of a third
person in case of his default. The person who gives the guarantee is called
the surety; the person in respect of whose default the guarantee is given is
called the principal debtor and the person to whom the guarantee is given is
called the creditor. A guarantee may be either oral or written.
The liability of a guarantor comes into existence upon the failure of a debtor.
If the guarantor extinguishes the liability of a debtor then the guarantor will
acquire all the rights of the creditor, which is known as Right of Subrogation.
Banks extend guarantees on behalf of their clients. These guarantees are
classified as financial guarantees and performance guarantees.

Financial Guarantees
The bank guarantees its customers credit-worthiness and his or her capacity
to take up financial risks. Financial guarantees are typically issued for the
following purposes:
O In lieu of Earnest Money/Tender deposit/Retention money.
O Issued to Government departments for releasing disputed claim money
like excise duty/customs duty etc.
For example, if a contractor wants to bid for a tender, he or she needs to
deposit a specified sum of money known as Earnest Money Deposit (EMD).
This amount will be refunded to him or her if the work is not allotted to him
or her. This involves blocking of funds for a specified period which varies
depending on the nature of contract. This can be avoided by submitting a
bank guarantee in the place of EMD. The bank undertakes to pay the money
if the contractor is awarded the work but fails to pay the EMD.

Performance Guarantees
The bank guarantees obligations that relate to the technical, managerial,
administrative experience and capacity of the customer. The liabilities under
the performance guarantees are reduced to monetary terms. Performance
guarantees typically cover the following areas:
O For performance of machinery/goods supplied deposit/Retention money
O For satisfactory performance of Turnkey projects for a specific period for
releasing disputed claim money like excise duty/customs duty, etc.
In the above example, if the contract is awarded to the contractor, then the
agency awarding the contract seeks an assurance that the contract
completed is up to their satisfaction. Hence, they insist for a bank guarantee
where a bank undertakes to compensate the agency for any loss suffered
consequent to poor performance/non-performance.

Deferred Payment Guarantee
This guarantee is issued for guaranteeing payment of specified amount over
a period of time. The required margin, security and commission payable are
determined on the basis of type of guarantee and creditworthiness of the
customer. In cases of equipment financing by banks, the manufacturer by
him or her or through a financing tie-up offers credit to the buyers at very
attractive terms to generate additional demand for his or her products.
However, the manufacturer may not be willing to assume the risk of default
by the buyer and consequently demand a guarantee from the buyers
bankers that the terms of such financing would be met.
otwithstanding the classification of guarantees into financial and
performance, the liability of a bank will always be determined in financial
terms and banks are obliged to pay the amount demanded by the
beneficiary subject to the limit up to which the bank agreed to make itself
liable under a guarantee.
While these guarantees do serve as non-fund based services serving the
purpose of working capital management, there are also instances where
banks may issue guarantees for financing capital equipment.
The Deferred Payment Guarantee (DPG) is a bank facility where the bank
does not directly extend a loan to a unit for acquiring equipment. Instead, it
extends a guarantee to the equipment manufacturer on behalf of its client
that the finance extended by the manufacturer (by himself or through its
preferred financier) would be repaid as per the terms agreed upon. The
advantage to the buyer here is that he or she benefits to the extent of
savings in interest charges accruing on account of opting for equipment
financing, minus the guarantee charges paid to the bank.
In the normal course where the guarantee does not transfer onto the
banker, the banker stands to earn fee-based income.
ormally, such financing is done by extending a term loan. Suppose a
supplier of capital equipment is willing to extend a long-term credit to the
buyer. This will involve the supplier taking a credit risk and also blocking
funds over the term of the credit. If the supplier is not willing to take the
credit risk then he or she may insist a bank guaranteeing the credit
extended to the buyer. In such circumstances, the bank can extend a
deferred payment guarantee. The bank, under the deferred payment
guarantee, undertakes to pay the installments if the buyer fails to pay the
same. . Under the scheme, the supplier draws different Bills of Exchange for
each of the installment and have the same accepted by the buyer and the
buyers banker as well. He or she will then have these bills discounted with
his or her banker, which will eliminate the need for him or her to block the
funds. Thus, the sale of capital equipment is effectively financed.
However, the credit risk is taken by the buyers banker since all others have
a banker to fall back on. When the sellers bank rediscounts these bills they
appear as contingent items in the banks balance sheet even though credit
has been initially extended to the seller. Hence, these items are added to the
et Bank Credit to obtain Gross Bank Credit.


Credit Derivatives to mitigate the credit risk

Credit derivatives are effective tools to hedge credit risk. Credit risk can be
defined as default risk arising on account of borrowers inability to pay back
loans. Any lending institution carries out credit analysis of a borrower and
prepares his risk profile. But, as no risk can be completely mitigated, there is
always a possibility of borrower default.

Due to large amount of defaults that took place in the US housing loan
markets in early 90s, banks found out innovative ways to hedge risks, which
led to expansion of derivative markets, where lenders could hedge against
the risks. In 2000, the notional principal outstanding in these markets was
$800 billion. Currently, this market stands somewhere around $600 trillion.
This shows the stupendous turnover taking place in this market.
Some of the commonly used credit derivatives are discussed as follows.

CREDIT DEFAULT SAPS (CDS)
This is the most popular credit derivative. The popularity of this derivative
can be seen from the fact that ADAMJEE, worlds largest insurer had worth
$60 trillion outstanding positions in CDS at the time of its taking over by
Federal Reserves.
In a credit-default swap (DS) the buyer pays a one-time or periodic fee to
the seller of protection for the right, in the case of default by a particular
borrower, to receive cash compensation or to sell a credit instrument issued
by the borrower at a specified price (near par). In contracts with extremely
low-risk counterparties, this instrument offers basically the same state-
contingent cash flows as a financial LC. therwise, the instrument involves
counterparty risk as well as the risk of the underlying instrument. As with a
financial LC and insurance contracts in general, the protection buyer in a DS
typically has the right of canceling (prepaying) the agreement.
This contract provides insurance against default by a particular company.
The company is known as reference entity, and the default by the company
is known as credit event. The buyer of the insurance obtains the rights to
sell bonds issued by the defaulting company at their face value when a credit
event occurs and the seller agrees to buy these bonds at face value when
credit event occurs. The total face value of a bond is called the notional
principle. The buyer of CDS makes periodic payments to the seller of CDS
until default occurs. nce the default occurs, the seller buys the bonds
issued by the defaulting company for its face value. The settlement in the
event of a default involves either physical delivery of the bonds or cash
payments.




TOTAL RETURN SAPS (TRS)
In a total-return swap (TRS) the protection buyer exchanges the total
returns on a specified underlying debt instrument for a set of stable cash
flows. The protection seller receives cash flows that match the interest and
principal payments plus the gains (minus the losses) of the underlying
instrument. As in the CDS, the TRS can involve counterparty risk in addition
to the risk of the underlying instrument. Also, as in the CDS, the TRS usually
allows the protection buyer to cancel the agreement.
A total return swap is a type of credit derivative. It is an agreement to
exchange total return on a bond (or any asset) for LIBR plus a spread. The
total return includes coupons, interest, and the gain or loss on the asset
over the life of the swap.



At the end of the life of the swap there is a payment reflecting the change in
the value of the bond, and subsequent payments are made.
This swap can be seen from 2 angles. For the payer of the bond, he gets a
hedge against the uncertainties in bond value for paying a premium above
LIBR. For the receiver of the bond, this transaction is equivalent to invest
in the reference bond by borrowing at the rate equal to LIBR + premium.

Collateralized Debt Obligations (CDOs)
CD is a way of creating securities with widely different risk characteristics
from a portfolio of debt instruments.

An example is shown below. In this, 4 types of securities are created from a
portfolio of bonds. The first basket has 5% of total bond principle and
absorbs all credit losses from the portfolio during the life of the CD until
they have reached 5% of total bond principle. The second basket has 10% of
total principal and absorbs all loses in excess of 5% up to maximum 15%.
The third basket has principal up to 10% and absorbs all the losses in excess
of 15% up to maximum 25%. The 4rth basket has 75% of the principal
amount and absorbs the residual losses. The yields specified are the returns
the investors are going to get in those specific baskets. For e.g. the investor
in the first basket is going to get 35% on his initial investment. nce the
value of total portfolio descends by 1%, his investment goes down by 20%,
the next time he is going to get 35% on 80% of his investment.






Other Instruments

CREDIT CARD
The credit card is an example of a common credit instrument. Using a credit
card to pay for a purchase creates a contract between the buyer and the
seller. Essentially, the seller is extending credit to the buyer with the
assumption that the company issuing the card will cover the amount of the
purchase. In turn, the issuer of the credit card is anticipating that the
cardholder will eventually pay off the amount of the debt along with
applicable interest and finance charges.
With this arrangement, credit card holders receive credit from the lenders
with the understanding that the same will be repaid in full at a future point
in time. This type of obligation may carry a specific date for repayment and
if the credit card holder is liable for a penalty. There are two main
advantages to the use of a credit card. First, the consumer does not have to
carry a great deal of currency in order to make purchases. Second, a credit
card can usually be replaced with relative ease when damage, loss, or theft
of the instrument takes place. This is in contrast to cash, which usually
cannot be replaced when damaged, stolen, or lost.

MULTI-OPTION CREDIT FACILITY (MOF)
Bond 1
Bond 2
Bond 3
.
.
.
Bond n

Average
Yield
8

Trust
2
nd
10
loss, yield
15
3
rd
10loss
Yield 7.5
Residual
loss, yield
6

1
st
5loss
Yield 35
In a multi-option credit facility (MF), the borrower has access to a range of
instrument types within a single facility or contract. In this case, the creditor
commits to provide credit up to a maximum amount, which can amortize
over time, to be drawn on in various ways largely at the borrowers
discretion. In a more general case, the borrower can receive a term loan and
then, as needed, obtain additional credit up to the remaining commitment
amount. This additional credit can take the form of additional funded
balances (revolvers), letters of credit, bankers acceptances, or some
combination of these types. f course, an MF can offer less than the full
menu of instrument types.

BANKER'S ACCEPTANCE (BA)
A bankers acceptance (BA) is another type of payment guarantee. A short-
term credit investment created by a non-financial firm and guaranteed by a
bank. A banker's acceptance or BA is a time draft drawn on and accepted by
a bank. In a BA, the bank certifies that it will stand behind time drafts
(usually post-dated cheques) issued by a customer. The customer may then
sell drafts endorsed as accepted by the bank at a discount to a funding
source that does not want to bear the issuers credit risk.
Before acceptance, the draft is not an obligation of the bank; it is merely an
order by the drawer to the bank to pay a specified sum of money on a
specified date to a named person or to the bearer of the draft. Upon
acceptance, which occurs when an authorized bank accepts and signs it, the
draft becomes a primary and unconditional liability of the bank.
If the bank is well known and enjoys a good reputation, the accepted draft
may be readily sold in an active market. Acceptances are traded at a
discount from face value on the secondary market. Banker's acceptances are
very similar to T-bills and are often used in money market funds.