Letter Of Credit

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DEFINITION of 'Letter Of Credit'

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 will be required to cover the full or remaining amount of the purchase.

INVESTOPEDIA EXPLAINS 'Letter Of Credit'

Letters of credit are often used in international transactions to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped.

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RELATED FAQS
  1. How do standby letters of credit help facilitate international trade?

    The nature of international trade inherently creates significant exposure to counterparty risk for those involved. Two parties ... Read Full Answer >>
  2. What is a standby letter of credit (SLOC)?

    A standby letter of credit, or SLOC, is a financial instrument that provides a guarantee of payment to a beneficiary in the ... Read Full Answer >>
  3. What's the difference between a letter of credit and a bank guarantee?

    Bank guarantees represent a more significant contractual obligation for banks than letters of credit do. A letter of credit ... Read Full Answer >>
  4. When is it necessary to get a letter of credit?

    A letter of credit is used when parties in a transaction don't know each other well and they want to be sure that each party ... Read Full Answer >>
  5. Can entities other than banks issue letters of credit?

    Legally speaking, any entity may issue a letter of credit; does not necessarily have to come from a bank. Other creditworthy ... Read Full Answer >>
  6. What is a bank's legal liability when issuing a letter of credit?

    A letter of credit is issued by a bank to a seller on behalf of a buyer. The letter guarantees the seller that the buyer ... Read Full Answer >>
  7. When are you legally required to get a letter of credit?

    You are legally required to obtain a letter of credit to guarantee a successful and risk-free transaction when dealing in ... Read Full Answer >>
  8. What's the difference between a bank guarantee and a letter of credit?

    A bank guarantee and a letter of credit are similar in many ways but they're two different things. Letters of credit ensure ... Read Full Answer >>
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