Cordelia Returns: Using Letters of Credit to Reduce Borrowing Costs

72 Pages Posted: 26 Jan 2009 Last revised: 17 Dec 2009

Date Written: January 25, 2009

Abstract

Letters of credit are used in hundreds of billions of dollars of financing annually. Although they are presumed to reduce borrowing costs, there is limited guidance on how they create this economic value. This paper explores the mechanisms through which letters of credit reduce borrowing costs. The paper then discusses another form of credit enhancement, bond insurance. After exploring the history and popularity of bond insurance, the instrument is compared with letters of credit. This paper proposes that bond insurance is riskier than letters of credit because (a) it is more susceptible to pricing error, (b) insurance companies are branching out into risky product lines, (c) courts are less likely to enforce a bond insurer's promise and (d) bond insurers may be less effectively regulated.

Keywords: Letter of credit, certification effect, underwriting, monitoring, collection, tax, institutional isomorphism, corruption, enforcing promises, bond insurance, guaranty, surety, monoline, actuarial pricing, insurance, regulation, reserves, Basel I, Basel II, rating agencies, credit enhancement

JEL Classification: G20, G21, G22, G28, K23

Suggested Citation

Gharagozlou, Alireza, Cordelia Returns: Using Letters of Credit to Reduce Borrowing Costs (January 25, 2009). University of Dayton Law Review, Vol. 34, p. 305, Available at SSRN: https://ssrn.com/abstract=1332843

Alireza Gharagozlou (Contact Author)

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
216
Abstract Views
1,486
rank
176,014
PlumX Metrics