Texas Bonds

A middle-party, Texas Bonds, have approached their bank with a request for the issuance of demand guarantees to an end-buyer in Africa in respect of the sale of three machines for the total sales value of USD 2.8m. The machines are to be purchased by Texas Bonds for USD 2.184m from the manufacturer in South East Asia and shipped direct to Africa. Supply lead time is as follows:

Machine 1 USD 0.654m to be shipped in month 4

Machine 2 USD 0.846m to be shipped in month 5

Machine 3 USD 1.300m to be shipped in month 7

The end-buyer in Africa is to pay Texas Bonds by export letter of credit, payable 750 days after the date of shipment.

The manufacturer in South East Asia requires Texas Bonds to arrange the issuance of an import letter of credit in their favour, payable 45 days after the date of shipment.

Texas Bonds have been able to negotiate an advance payment of 30% of the contract value from the end-buyer.

The following demand guarantees are to be issued in favour of the end- buyer on contract signature:

Advance payment guarantee USD 0.840m (30%) valid for 8 months

Performance guarantee USD 0.280m (10%) valid for 12 months

Warranty guarantee USD 0.280m valid for 24 months

The bank of Texas Bonds wish to minimise their risk exposure on this transaction and therefore need to consider the best way of structuring the deal.

Questions:

1. What are the risks involved?

2. What are your recommendations?