CCP CCP Credit Insurance & Risk Mitigation 2 — Questions and Answers
Question 1: A surety bond used in credit differs from trade credit insurance primarily because:
- Surety bonds cover domestic transactions only
- The surety has the right of subrogation and recovery from the principal (buyer) after paying a claim (Correct answer)
- Surety bonds are purchased by the seller to protect its own receivables
- Surety bonds are regulated by credit bureaus
Correct answer: The surety has the right of subrogation and recovery from the principal (buyer) after paying a claim
In a surety arrangement the surety (bond issuer) can recover from the principal (the obligated party) after paying the obligee, unlike credit insurance where the insurer typically bears the loss.
Question 2: What risk mitigation technique involves requiring a customer to pay for goods before or upon delivery, used when credit risk is unacceptable?
- Open account terms
- Cash in advance (CIA) or cash on delivery (COD) (Correct answer)
- Net 60 terms with a personal guarantee
- Factoring the receivable
Correct answer: Cash in advance (CIA) or cash on delivery (COD)
CIA and COD eliminate credit exposure entirely by ensuring payment is received before or at the time the seller parts with goods.
Question 3: Accounts receivable factoring transfers credit risk to the factor in which arrangement?
- Recourse factoring
- Non-recourse factoring (Correct answer)
- Invoice discounting
- Supply chain finance
Correct answer: Non-recourse factoring
In non-recourse factoring the factor absorbs the credit risk of buyer non-payment due to insolvency, whereas recourse factoring leaves that risk with the seller.
Question 4: Which credit risk mitigation tool requires the buyer's bank to guarantee payment to the seller upon presentation of compliant documents?
- Open account with credit insurance
- Documentary letter of credit (LC) (Correct answer)
- Standby letter of credit (SBLC)
- Bank guarantee on demand
Correct answer: Documentary letter of credit (LC)
A documentary LC obligates the issuing bank to pay upon receipt of specified trade documents that conform to LC terms, shifting payment risk from the buyer to the bank.
Question 5: When a credit manager uses a personal guarantee from a business owner, which risk is being mitigated?
- Market risk from commodity price changes
- The risk that a corporate entity lacks assets to satisfy a debt (Correct answer)
- Currency translation risk on foreign receivables
- The risk of buyer fraud
Correct answer: The risk that a corporate entity lacks assets to satisfy a debt
A personal guarantee gives the creditor recourse to the owner's personal assets if the business entity cannot pay, addressing the limited-liability shield of incorporated buyers.
Question 6: What is the main benefit of supply chain finance (reverse factoring) from a credit risk management perspective?
- It eliminates the need for credit limits on buyers
- It leverages the buyer's strong credit rating to provide sellers with early payment at low discount rates (Correct answer)
- It requires the seller to post collateral against receivables
- It replaces trade credit insurance for all export transactions
Correct answer: It leverages the buyer's strong credit rating to provide sellers with early payment at low discount rates
Reverse factoring uses the buyer's creditworthiness so the seller can access early payment at funding costs close to the buyer's borrowing rate, reducing both liquidity and credit risk for the seller.
CCP CCP Credit Insurance & Risk Mitigation 2
A surety bond used in credit differs from trade credit insurance primarily because: