The following points highlight the top three types of credit instruments. The types are: 1. Promissory Note 2. Bill of Exchange (or Hundi) 3. Cheque.
Type # 1. Promissory Note:
A promissory note is a document in which a person promises to pay another a specified sum at a certain date. The payee, i.e., the person to receive the amount, can sign at the back of the note, and the note becomes negotiable. It can act as a medium of exchange provided those who accept it, have confidence in the maker or the endorser.
Type # 2. Bill of Exchange (or Hundi):
A bill of exchange is an order given by a seller of the goods to the buyer to pay a certain sum of money for value received by himself or a third person named therein or his order, after a specified period of time, usually varying from three to six months. Before the bill can be used as a credit instrument, it requires to be accepted by the drawee.
Once the bill has been accepted three course are open to the drawer:
(i) He can hold it himself until it is due for payment,
(ii) He might be able: to discount it with a bank to receive payment at once, and
(iii) He might be able to use it, after he has endorsed it, to pay a creditor of his own, if the creditor is willing to be paid in this way.
Such a bill is used in both internal and external trade. Where the drawer and the drawee or the payee reside in the same country, the bill is called an inland bill of exchange.
The bill of exchange, inland or foreign, is very useful for making payments for trading, particularly in foreign trade transactions. It eliminates the necessity of cash payment or payments by gold. As this instrument is negotiable, the traders can meet their present financial liabilities by getting these future claims duly discounted and en-cashed.
Type # 3. Cheque:
A cheque by far the most important credit instrument is a written order by a person on a bank to pay on demand a certain sum of money either to himself or to his order or to his bearer. It is a credit instrument so long as it is not presented for encashment. It rests on the confidence of the payee both in the person who draws it and in the bank on which it is drawn.
It is to be noted that a cheque is not legal tender, but is used as money or near-money or money-substitute, it has several advantages. It reduces the use of cash money and makes the payment very smooth and easy. The payment in cheque is also safe when it is crossed.
But the payment by cheque is not always accepted. Besides, it cannot be transferred many times through endorsement and as such it has a limited circulation. Owing to these reasons, a cheque is not treated as money; it is merely a money-substitute.