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What is a Letter of Guarantee?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 19 November 2016
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    Conjecture Corporation
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A letter of guarantee is a document that is often issued by a bank or other financial institution. The purpose of the document is usually to confirm that a client has entered into a contract to purchase specified goods and services, and has made a commitment to honor any financial obligations that are involved with that contract. In situations where property or other assets have been pledged as collateral for the purchase, a letter of guarantee confirms that those assets will be delivered to the seller in the event of default on the part of the buyer.

This same type of document can be used as a means of affirming the existence and availability of an asset to underwrite some type of investment opportunity. The most usual application of a letter of guarantee in this scenario is for a bank to issue the letter on behalf of a call writer. The text of the letter confirms the existence of the pledged asset and commits to delivering the asset to the recipient of the letter, in the event that the call writer is unable to meet his or her obligation for any reason.

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In format, a letter of guarantee is normally a short document that addresses a specific transaction. The text contains data that establishes the identity of the buyer, his or her relationship with the bank, and the nature and general value of the asset that is pledged as collateral. The letter will also confirm the basics of the working agreement between the two parties, thus establishing the recognition of the contract and the bank’s knowledge of that contract. It is not unusual for a a guarantee letter to also include data regarding the steps that must be followed to claim the asset in the event that the buyer fails to follow through with the terms of the sale.

One of the main advantages of this type of letter is that it allows consumers to work with businesses or participate in an investment opportunity that would be beyond their ability otherwise. A number of reasons may cause a seller to be wary of entering into a business relationship, such as a poor credit rating, a lack of credit history, or any other factor that may in some way increase the risk of default. The letter of guarantee helps to remove those obstacles, since the document does confirm the nature of the asset presented as collateral, and further affirms that that asset will be delivered in a timely manner, should the buyer default. A guarantee of this type is especially important when the transaction involves the purchase of stocks or other securities, and the asset that is pledged as collateral is not held in any type of brokerage account.

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