Time Draft

A Time Draft (also known as a usance draft) is essentially a post-dated check with superpowers, primarily used in international trade. Think of it as a formal IOU that specifies a payment will be made at a future, predetermined date—not immediately upon presentation. For example, a German car parts manufacturer might sell components to an American automaker. The German seller can issue a time draft that requires the American buyer to pay for the parts 60 days after receiving them. This delay gives the buyer crucial time to incorporate the parts into their cars and maybe even sell some before the bill is due. It's a form of built-in financing that greases the wheels of global commerce. This contrasts sharply with a Sight Draft, which works like a regular check and demands payment on the spot. As a legally binding Bill of Exchange, the time draft provides security for the seller while offering valuable flexibility to the buyer.

The magic of a time draft lies in a document-driven process that ensures both parties in a trade deal are protected, even when they are thousands of miles apart and may have never met. The process is often facilitated by banks and a Letter of Credit to minimize risk for everyone involved.

Understanding a time draft means getting to know the cast of characters:

• The Drawer: This is the seller (Exporter) who writes or “draws” the time draft. They are the one demanding payment.
• The Drawee: This is the buyer (Importer) or, more commonly, the buyer's bank. The drawee is the one who is ordered to pay the draft when the time comes.
• The Payee: This is the party who ultimately gets the money. It's usually the drawer (the seller), but the seller can sometimes sell the draft to another party.

Let's walk through a simple scenario.

1. Step 1: The Deal. “USA Widgets Co.” agrees to sell $100,000 worth of widgets to “UK Gadgets Ltd.” The payment terms are “90 days after acceptance.”
2. Step 2: The Shipment. USA Widgets ships the goods and gathers all the necessary shipping documents, including the bill of lading, insurance certificate, and, crucially, a time draft for $100,000.
3. Step 3: The Presentation. USA Widgets' bank sends these documents to UK Gadgets' bank in London.
4. Step 4: The Acceptance. The London bank reviews the documents with its client, UK Gadgets. If everything is in order, UK Gadgets “accepts” the draft by signing it. This act transforms the draft into a legally binding promise to pay $100,000 in 90 days. The date of acceptance is stamped on the draft, starting the 90-day clock.
5. Step 5: The Payment. After 90 days, the London bank debits UK Gadgets' account for $100,000 and transfers the funds to USA Widgets' bank.

“This is all fascinating,” you might say, “but I'm an investor, not a widget exporter. Why should I care?” The answer lies in what can happen to a time draft after it has been accepted.

Once a time draft is accepted and guaranteed by a bank, it becomes a Banker's Acceptance. This transforms it from a simple trade document into a high-quality, low-risk debt instrument. It's now a promise from a reputable bank, not just a foreign company. This Banker's Acceptance is a negotiable instrument, meaning it can be bought and sold. The exporter (USA Widgets Co.) might not want to wait 90 days for their $100,000. So, they can sell the Banker's Acceptance immediately on the Money Market to an investor for a slight discount, say, $99,500. USA Widgets gets its cash fast, and the investor who bought it will receive the full $100,000 from the bank in 90 days, earning $500 in interest.

For the value investor, Banker's Acceptances are interesting because they are a type of cash equivalent.

• Rewards: They offer a higher yield than holding cash in a bank account and are generally more lucrative than U.S. Treasury Bills (T-bills), another ultra-safe investment. The return is predictable and stable.
• Risks: The risk is incredibly low. It hinges on the guaranteeing bank going bust within the short life of the acceptance (typically 30 to 180 days). For a major international bank, this is a very remote possibility. The investment is also backed by the underlying shipment of goods, adding another layer of security.

While you won't be trading time drafts yourself, understanding them reveals the origin of Banker's Acceptances—a key component of many money market funds and institutional portfolios. For a value investor looking to park cash safely while earning a modest return, knowing about these instruments is part of understanding the full landscape of low-risk assets. It's a peek behind the curtain of global finance, showing how the real economy of goods and services creates safe, tradable financial instruments.