Chapter 4: Documentary Letters of Credit (CAIIB – Paper 2)
1. What is the primary purpose of a Letter of Credit (LC)?
A. To provide insurance for goods in transit
B. To act as a legal contract for employment
C. To guarantee payment to the exporter upon compliance with terms
D. To give ownership of goods to the bank
A Letter of Credit is a bank instrument that guarantees payment to the exporter once they comply with the terms and submit the required documents.
2. Which of the following is a type of Letter of Credit that can be transferred to another beneficiary?
A. Revocable LC
B. Transferable LC
C. Sight LC
D. Back-to-Back LC
A Transferable LC allows the original beneficiary to transfer part or whole of the credit to another party, typically used by intermediaries or exporters sourcing goods from suppliers.
3. What distinguishes a Revocable LC from an Irrevocable LC?
A. A Revocable LC can be amended or cancelled by the issuing bank without prior consent of the beneficiary
B. A Revocable LC is always payable at sight
C. A Revocable LC cannot be transferred
D. A Revocable LC requires collateral from the exporter
In a Revocable LC, the issuing bank can amend or cancel the credit without notifying the beneficiary, unlike an Irrevocable LC which cannot be changed without beneficiary consent.
4. Which type of LC requires payment immediately upon presentation of compliant documents?
A. Back-to-Back LC
B. Red Clause LC
C. Transferable LC
D. Sight LC
A Sight LC requires the bank to make payment immediately upon presentation and verification of the documents stipulated in the credit.
5. Which LC allows the beneficiary to receive an advance before shipment of goods?
A. Deferred Payment LC
B. Red Clause LC
C. Irrevocable LC
D. Confirmed LC
A Red Clause LC provides the beneficiary with an advance payment prior to shipment to help finance the production or procurement of goods.
6. Which bank is primarily responsible for checking documents under a Letter of Credit?
A. Exporter’s bank
B. Central Bank
C. Advising / Negotiating Bank
D. Importer’s Branch Bank
The Advising or Negotiating Bank examines the documents presented by the exporter to ensure they comply with the terms of the LC before forwarding to the issuing bank for payment.
7. What is the purpose of UCP 600 in international trade?
A. To regulate currency exchange rates
B. To standardize practices for documentary credits globally
C. To provide insurance against shipment loss
D. To determine tariffs and customs duties
UCP 600 (Uniform Customs and Practice for Documentary Credits) provides a set of internationally recognized rules for the issuance and operation of letters of credit, ensuring consistency in trade finance.
8. Under UCP 600, which article defines the responsibilities of the issuing bank?
A. Article 5
B. Article 14
C. Article 18
D. Article 7
Article 7 of UCP 600 specifies that the issuing bank must honor the credit if the presented documents comply strictly with the terms and conditions of the LC.
9. Which article of UCP 600 deals with the discrepancies in documents presented under a Letter of Credit?
A. Article 3
B. Article 14
C. Article 10
D. Article 19
Article 14 of UCP 600 allows the bank to refuse documents if they contain discrepancies, giving a clear guideline on handling non-compliant documents.
10. In the operation of an LC, what does a “Negotiation” mean?
A. The process by which a bank buys the export documents and advances funds to the beneficiary
B. Discussion between importer and exporter for price settlement
C. Bank correcting discrepancies in documents
D. Issuing a new LC to replace an existing one
Negotiation under an LC refers to the bank purchasing the documents from the beneficiary and paying (or agreeing to pay) them before receiving reimbursement from the issuing bank.
11. Who holds the primary liability to honor a Letter of Credit?
A. Beneficiary
B. Issuing Bank
C. Advising Bank
D. Applicant’s Supplier
The issuing bank is primarily liable to pay the beneficiary once the terms and conditions of the LC are met, regardless of the applicant’s financial position.
12. Which party has the right to request amendments in a Letter of Credit?
A. Beneficiary alone
B. Advising Bank alone
C. Applicant (importer) with the consent of the beneficiary
D. Transport Company
The applicant can request amendments to the LC, but any change requires the beneficiary’s consent as it affects their rights and obligations under the credit.
13. In case of discrepancy in documents, who has the right to refuse payment?
A. Applicant
B. Beneficiary
C. Transporter
D. Issuing Bank
The issuing bank has the right to refuse payment if the documents presented do not comply strictly with the terms of the LC, as per UCP 600 guidelines.
14. Which party is responsible for ensuring that the goods shipped comply with the LC terms?
A. Beneficiary (exporter)
B. Issuing Bank
C. Advising Bank
D. Applicant (importer)
The exporter is responsible for ensuring that the goods shipped and documents presented comply with the terms and conditions of the LC to receive payment.
15. Who bears the risk if the issuing bank becomes insolvent before honoring the LC?
A. Beneficiary’s bank
B. Applicant
C. Beneficiary (exporter)
D. Transporter
If the issuing bank fails to honor the LC due to insolvency, the exporter bears the risk of non-payment, unless a confirmed LC is used which involves a confirming bank.
16. What is the primary purpose of scrutinizing documents under an LC?
A. To ensure documents strictly comply with LC terms before payment
B. To verify the quality of goods shipped
C. To calculate customs duty
D. To confirm transport insurance coverage
Scrutiny ensures that all documents presented comply exactly with the terms of the LC, reducing the risk of discrepancies and payment issues for the bank.
17. What does the term “crystallization of LC” refer to?
A. Physical delivery of goods
B. Negotiation of LC documents
C. Transfer of LC to another bank
D. Recognition of a bank’s liability to pay once documents comply
Crystallization refers to the point at which the issuing bank’s liability to honor the LC becomes definite, once the beneficiary submits documents complying with the LC terms.
18. Which of the following is an important follow-up step after LC documents are sent to the issuing bank?
A. Customs clearance of goods
B. Tracking payment status and ensuring timely negotiation
C. Issuing insurance policy
D. Signing shipping contract
Banks must follow up on the LC to ensure documents are negotiated timely, discrepancies are resolved, and payment is made according to the credit terms.
19. Which of the following is a key safeguard for banks while operating under an LC?
A. Allowing partial compliance of documents
B. Ignoring discrepancies to maintain customer relations
C. Requiring strict compliance of documents and clear terms in LC
D. Avoiding LC operations for exporters
Banks safeguard themselves by insisting on strict compliance with LC terms and clear documentation, reducing the risk of payment disputes or fraud.
20. What is the role of the negotiating bank in LC document follow-up?
A. To check documents for discrepancies and forward to issuing bank for payment
B. To physically deliver goods to the importer
C. To provide insurance against shipment loss
D. To amend the LC unilaterally
The negotiating bank examines the documents for compliance with the LC, notifies the beneficiary of discrepancies if any, and forwards the documents to the issuing bank for payment.
21. Which of the following is a major risk for the issuing bank under an LC?
A. Risk of fluctuating exchange rates only
B. Risk of transport delays only
C. Risk of paying for non-compliant documents or fraud
D. Risk of customs duties changes only
The issuing bank’s main risk is that it may have to honor payment for documents that appear compliant but are fraudulent or do not correspond to the actual goods shipped.
22. What type of risk arises if the beneficiary presents documents that are not in accordance with the LC?
A. Credit risk of the applicant
B. Documentary / operational risk
C. Market risk
D. Legal risk of transport
Documentary or operational risk arises when the documents presented by the beneficiary do not strictly comply with LC terms, potentially causing payment disputes.
23. Which risk is minimized when a bank obtains a Standby Letter of Credit (SBLC)?
A. Market risk
B. Operational risk in shipment
C. Currency fluctuation risk
D. Credit / default risk of the applicant
An SBLC acts as a guarantee, ensuring that the beneficiary will receive payment in case the applicant fails to perform, thereby mitigating credit or default risk.
24. How does a Standby LC differ from a commercial LC?
A. SBLC is used for paying exporters directly for shipments
B. SBLC serves as a backup guarantee and is drawn only if the applicant defaults
C. SBLC cannot be issued by a bank
D. SBLC requires physical goods to be shipped first
Unlike a commercial LC, an SBLC functions as a contingency guarantee, providing payment only if the applicant fails to fulfill obligations, similar to a bank guarantee.
25. Which party primarily benefits from a Standby LC?
A. Beneficiary / creditor who wants assurance of payment
B. Issuing bank
C. Applicant / importer
D. Transport company
The beneficiary or creditor benefits from an SBLC as it provides assurance of payment even if the applicant defaults on the underlying obligation.
26. What is the primary purpose of URR 725?
A. To regulate exchange rates between banks
B. To standardize trade documentation procedures
C. To provide uniform rules for bank-to-bank reimbursement under LCs
D. To govern export-import licensing procedures
URR 725 establishes internationally recognized rules for the reimbursement of banks involved in documentary credit transactions, ensuring clarity and consistency in payments.
27. Which bank is reimbursed under URR 725 rules?
A. Applicant’s bank
B. Nominated / negotiating bank that honored the LC
C. Central Bank only
D. Transport bank
The nominated or negotiating bank that has honored the beneficiary under the LC is reimbursed by the issuing bank or reimbursing bank as per URR 725 rules.
28. What is required for a bank to claim reimbursement under URR 725?
A. Oral request from beneficiary
B. Approval from transport company
C. Presentation of customs clearance documents
D. Presentation of complying documents in accordance with LC terms
The reimbursing bank will pay the nominated bank only if the documents presented comply strictly with the LC terms, as per URR 725 procedures.
29. Which of the following is a key feature of URR 725?
A. Governs export insurance
B. Provides rules for reimbursement claims between banks
C. Regulates foreign exchange rates
D. Specifies shipping routes for exports
URR 725 lays down the procedures for banks to claim reimbursement when they honor a documentary credit, ensuring smooth inter-bank payments in LC transactions.
30. Under URR 725, the reimbursing bank’s obligation arises:
A. Only upon receipt of complying documents from the nominated bank
B. Immediately after LC issuance
C. After shipment of goods only
D. Upon verbal confirmation from the beneficiary
The reimbursing bank’s obligation is triggered only when the nominated bank presents documents that comply with the LC terms, ensuring proper documentation and reducing disputes.
31. What is the main objective of ISBP 745?
A. To regulate currency exchange rates
B. To enforce customs clearance procedures
C. To provide detailed guidance on the examination of LC documents
D. To determine shipping routes for exports
ISBP 745 offers detailed guidance to banks on how to examine documents presented under a Letter of Credit, ensuring uniformity in documentary credit practice worldwide.
32. Which of the following does ISBP 745 complement?
A. URR 725 rules
B. UCP 600 rules
C. Export-Import Policy
D. Banking Regulation Act
ISBP 745 complements UCP 600 by providing practical guidance on document examination, helping banks apply UCP 600 rules consistently.
33. Which of the following is an important purpose of Incoterms in international trade?
A. To regulate letter of credit issuance
B. To provide guidance on document scrutiny
C. To control currency exchange rates
D. To define responsibilities, costs, and risks between buyer and seller
Incoterms (International Commercial Terms) clarify the division of costs, risks, and responsibilities between buyer and seller in international trade transactions.
34. Which Incoterm requires the seller to deliver goods to a named port of shipment and clear them for export?
A. CIF (Cost, Insurance, Freight)
B. FOB (Free on Board)
C. EXW (Ex Works)
D. DDP (Delivered Duty Paid)
Under FOB, the seller delivers the goods on board the ship at the named port of shipment and is responsible for export clearance, after which risk transfers to the buyer.
35. Under which Incoterm does the seller bear all costs and risks until the goods are delivered to the buyer’s premises?
A. DDP (Delivered Duty Paid)
B. CIF (Cost, Insurance, Freight)
C. EXW (Ex Works)
D. FOB (Free on Board)
Under DDP, the seller is responsible for delivering the goods to the buyer’s premises, covering all costs, risks, and import duties until delivery.
36. In a case study where the LC documents contain a discrepancy, who is typically responsible for resolving the issue?
A. Transport company
B. Importer alone
C. Exporter alone
D. Issuing and negotiating banks collaboratively
When documents under an LC contain discrepancies, the issuing bank typically communicates with the negotiating bank and the applicant (importer) to resolve the issue before payment is made.
37. In a case where the issuing bank becomes insolvent, which safeguard can protect the beneficiary?
A. Back-to-back LC
B. Transferable LC
C. Confirmed LC by another bank
D. Red Clause LC
A confirmed LC involves a second bank guaranteeing payment, protecting the beneficiary if the issuing bank defaults or becomes insolvent.
38. In a case study, the applicant requests an amendment in the LC after shipment. What is the key consideration?
A. The advising bank can amend unilaterally
B. The amendment requires the beneficiary’s consent before becoming effective
C. The shipment must be recalled immediately
D. The applicant can ignore the original LC
Any amendment requested by the applicant after shipment requires the beneficiary’s agreement, as it affects their rights and obligations under the LC.
39. In a scenario where partial shipment is allowed under the LC, what is the bank’s responsibility?
A. To examine documents for each partial shipment and honor compliance
B. To reject all partial shipments
C. To consolidate documents before payment
D. To pay only after the final shipment
When an LC allows partial shipments, the bank must examine documents for each shipment and honor payment for each portion that complies with the LC terms.
40. In a case study, the beneficiary presents documents via a negotiating bank that appear compliant but contain a hidden discrepancy. What should the bank do?
A. Make immediate payment to maintain customer relations
B. Ignore the discrepancy as it may be minor
C. Seek approval from transport company
D. Notify the issuing bank and applicant before making payment
If a hidden discrepancy exists, the negotiating bank must notify the issuing bank and applicant before honoring the documents, protecting against fraud and non-compliance.
