What is a 'letter of credit' in international trade?

A 'letter of credit' is primarily a financial guarantee issued by a bank on behalf of a buyer, ensuring that a seller will receive payment for goods or services provided, as long as the seller meets the conditions outlined in the letter. This mechanism is particularly crucial in international trade, where the parties may not have established trust or familiarity with one another.

When a buyer requests a letter of credit from their bank, the bank undertakes to pay the seller a specified amount upon the seller's presentation of certain required documents—such as shipping documents or invoices—that confirm the shipment of goods. This process mitigates the risk for the seller, as they are assured of payment upon complying with the detailed terms stated in the document.

Although options like a document guaranteeing the buyer will receive products or a policy preventing fraud in international transactions may touch on aspects of trade, they do not encapsulate the primary function of a letter of credit, which is fundamentally about the assurance to the seller regarding payment. Therefore, the correct option accurately reflects the core purpose and operation of a letter of credit in facilitating secure international transactions.