You should keep in mind the following points to understand the definition: The person who writes out the order to pay is called the drawer. The person upon whom the bill of exchange is drawn (who is ordered to pay) is called the drawee. The drawee may "accept" the bill. This is a special use of the word accept because it means that he accepts to pay the amount payable expressed in the bill, i.e. if he accepts the obligation to pay he writes "accepted" across the face of the bill and signs it. From that time on he is know as the "acceptor" of the bill and has absolute liability to honor the bill on the due date. The amount of money must be mentioned clearly. For example, I cannot make out a bill requiring someone to pay the value of my car or house. That is an uncertain sum. It must say "five thousand dollars or ten thousand dollars" etc. The time must be fixed or at least be determinable.
For example, "sixty days after date" is quite easily determinable. If the bill is made out on first July, it will be 29th august. The person who is entitled to receive the money from the acceptor is called the "payee". It is usually the drawer who is supplying goods to the value of the bill, and wants to be paid for them. If the drawer decides, the bill can be made payable to someone else by endorsing it. That is why the definition says, to pay..... to, or the the order of, a specified person. A bill can be made payable to a bearer, but it is risky, since any finder of the bill or any thief, can claim the money from the acceptor. Format of Bill of Exchange: Now read the definition again and see the format of the bill of exchange below:
Important Points: This bill is drawn by the peter & Co., so the drawer of the bill is peter & Co. The bill is drawn upon William & Co., so they are drawee of the bill. They have not yet accepted the bill, and so are not liable to pay it at maturity. The bill is an unconditional order in writing. It says "pay ten thousand dollars to Peter & Co." it does not say "provided you are in funds". It just says "pay!". It is addressed by one person (Peter & Co.) to another (William & Co.) and is signed by the person giving it (Peter & Co.). The date is easily determinable it is 90 days after first July, which is 29 September, 20.... The sum of money is very certain, ten thousand US dollars. The bill is payable to, or to the order of, Peter & Co. How a Bill of Exchange Works? A person who wants to purchase goods but has no money, may agree to accept a bill of exchange drawn upon him at some future date for the value of the goods he wants to purchase. For example, Mr. B (a retail trader) wishes to purchase furniture from a furniture manufacturer (Mr. A) but has no money. Mr. A is agreed to sell furniture for a 90 days credit worth $10,000. The drawer (Mr. A) draws a bill for $10,000 on the customer (Mr. B), the drawee, who accepts it (thus becoming the acceptor of the bill) and returns it to the drawer. The drawer delivers the furniture and has a 90 days bill for $10,000. He can keep the bill till due date and present it on the due date before the acceptor. When a drawee (the acceptor) acknowledges the obligation in the bill he is bound by law to honor the bill on the due date. If he is a reputable person the bill is as good as money, and any bank will discount it. There are special kinds of banks which do this job and they are called discount houses. What do the discount houses do? They cash the bill by giving the drawer the present value of the bill. Present Value = Face value of the bill - Interest at agreed rate for the time the bank has to wait So the drawer who discounts the bill with the bank gets less than the face value. On the due date the bank will present the bill to the acceptor, who honors it by paying the full value. The bank has earned the amount of interest it deducted when it discounted the bill. Where does the acceptor get the money to honor the bill? The answer is that he was given 90 days to sell the goods at profit, and therefore, he is liable to honor the bill. Now it is hoped that you will be able to follow what is happening in the following diagrams: