DEFINITION of 'Aval'

Aval is a guarantee that a third party adds to a debt obligation. This third party is not the payee or the holder, but ensures payment should the issuing party default. The debt obligation could be a note, bond, promissory note, bill of exchange or draft. The third party providing the aval is usually a bank or other lending institution.

BREAKING DOWN 'Aval'

Since avals can be forged, all parties should take caution when accepting these notes. Banks usually only provide an aval to issuers with very good credit ratings. The process of avalizing mainly occurs Europe; in the United States, banks have restrictions as to what instruments they may use to provide aval.

While avals have a range of functions, they can come particularly in handy with a range of purchase agreements, including a bond purchase agreement, cross purchase agreement, and matched sale-purchase agreement.

A bond purchase agreement is a legally binding document between a bond issuer and an underwriter, which outlines the terms of a bond sale, including the sale price, interest rate, maturity, redemption provisions, sinking fund provisions, and reasons why the agreement may be canceled. A cross-purchase agreement allows a company's major shareholders to purchase the interest or shares of a partner who has deceased, has become incapacitated, or who is retiring.

A matched sale-purchase agreement is an arrangement in which the U.S. Federal Reserve (the Fed) sells government securities (U.S. Treasuries) to an institutional dealer or the central bank of another country. The party purchasing U.S. treasuries will agree to sell them back to the Fed within a short period of time (generally two weeks or less). The Fed repurchases the Securities for the same price at which they originally sold them to decrease banking reserves.

In all of these cases, the ability to avalize comes in handy for additional security purposes. Particularly when dealing with large sums that multiple stakeholders rely on, having an external bridge of support can bolster the deal.

Aval and Credit Ratings

As mentioned above, banks often only provide avals to issuers with good credit ratings. Companies, municipalities, and even sovereign nations can rack up stronger ratings by taking on loans and paying them off in a complete and timely manner, along with a range of other tactics. Credit rating agencies such as Standard & Poor’s (S&P), Moody’s, or Fitch generally carry out credit assessments. Each entity that seeks a credit rating for itself or for one of its debt issues will pay an agency to do this.

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