letter of credit

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letter of credit, commercial instrument through which a bank or other financial institution instructs a correspondent institution to advance a specified sum of money to the bearer. The document is called a circular letter of credit when it is not addressed to any particular correspondent. In effect, a letter of credit is a draft, save that the amount is merely stated as a maximum not to be exceeded. Letters of credit, mainly used by travelers, greatly simplify nonlocal business transactions. Those who issue such letters are usually so well known that any bank will honor the letter upon proper identification. Travelers' checks are a modified form of a letter of credit. They are issued in coupons, upon whose face a value is usually expressed in terms of the currency of a particular country. In the United States they are issued by express companies and banks. Circular letters of credit require that each payment, as it is made, be endorsed by the firm making payment so that other banks may know how much of the total credit has been used.

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LETTER OF CREDIT

A written instrument from a bank or merchant in one location that requests that anyone or a specifically named party advance money or items on credit to the party holding or named in the document.

When a letter of credit is used, repayment of the debt is guaranteed by the bank or merchant issuing it. For example, if a bank is aware that a prominent citizen is trustworthy and can safely be relied upon to settle the debts which he or she incurs, then a letter of credit will be offered to that person on the basis of his or her good reputation so the person can travel without carrying large sums of money.

Letters of credit were used frequently before credit cards and travelers' checks were in common usage.

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let·ter of cred·it • n. a letter issued by a bank to another bank (typically in a different country) to serve as a guarantee for payments made to a specified person under specified conditions.

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letter of credit: see credit, letter of.

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