How Does a Bill of Exchange Work?

A bill of exchange is a three-party, non-interest, written order that is created by the first party, the drawer, and it presents an order for the second party, or the payor, to make a sum payment to a third-party, the payee. If it is a sight bill, the payment is to be made immediately, and if it is a term bill, the payment is set for a future date. The payor accepts the draft by signing it, converting the draft into a post-dated check and a binding contract.

Bills of exchange are similar to checks and promissory notes, but bills of exchange are transferable. The orders can be drawn up by individuals or banks, and they can bind one party to pay a third party that was not involved in its creation. If a bill of exchange is issued by a bank, they are referred to as bank drafts. Similarly, if a bill is issued by an individual, they are referred to as trade drafts.

At the Geneva Convention in 1930, a uniform law of standards for bills of exchange and promissory notes was set. Bills of exchange must contain all information that is pertinent to the parties involved as well as the payments to be made.