HOW MONEY IS MADE IN FOREIGN EXCHANGE. THE OPERATIONS OF THE FOREIGN DEPARTMENT

Where documents accompany the draft and the merchandise is formally hypothecated to the buyer of the draft, it might not be thought that the standing of the drawer would be of such great importance. Possession of the merchandise, it is true, gives the banker a certain form of security in case acceptance of the bill is refused by the parties on whom it is drawn or in case they refuse to pay it when it comes due, but the disposal of such collateral is a burdensome and often expensive operation. The banker in New York who buys a sixty-day draft drawn against a shipment of butter is presumably not an expert on the butter market and if he should be forced to sell the butter, might not be able to do so to the fullest possible advantage. Employment of an expert agent is an expensive operation, and, moreover, there is always the danger of legal complication arising out of the banker's having sold the collateral. It is desirable in every way that if there is to be any trouble about the acceptance or payment of a draft, the banker should keep himself out of it.

A concrete illustration of the dangers attendant upon the purchase of commercial long bills from irresponsible parties is to be found in what happened a few years ago to a prominent exchange house in New York. This house had been buying the bills of a certain firm for some little time, and everything had gone well. But one day acceptance of a bill for £2,000 was refused by the party abroad, and the news cabled that the bill of lading was a forgery and that no such shipment had ever been made. Wiring hurriedly to the inland city in which was located the firm which drew the bill, the New York bank received the reply that both partners had decamped. What had happened was that, about to break up, the "firm" had drawn and sold several large bills of exchange, with forged documents attached, received their money for them, and then disappeared. Neither of them was ever apprehended, and the various bankers who had taken the exchange lost the money they had paid for it. Forgery of the bill of lading in this case had been a comparatively easy matter, the shipment purporting to have been made from an obscure little cotton town in the South, the signature of whose railroad agent was not at all known.

This forgery is only one example of the trickery possible and the extreme care which is necessary in the purchase of bills of this kind. And not only must the standing of the drawer be taken into consideration, but the standing of the drawee is a matter of almost equal importance—‌after the "acceptance" of the bill, the parties accepting it being equally liable with its maker. The nature of the merchandise, furthermore, and its marketability are further considerations of great importance. Cotton, it will readily appear, is an entirely different sort of collateral from clocks, or some specialty in which the market may vary widely. The banker who holds a bill of lading for cotton shipped to Liverpool can at any moment tell exactly what he can realize on it. In the case of many kinds of articles, however, the invoice value may differ widely from the realizable value, and if the banker should ever be forced to sell the merchandise, he might have to do so at a big loss.

Returning to the actual operation of selling bankers' demand against remittances of long bills, it appears that the successive steps in an actual transaction are about as follows:

The banker in New York having ascertained by cable the rate at which bills "to arrive" in London by a certain steamer will be discounted, buys the bills here and sends them over, with instructions that they be immediately discounted and the proceeds placed to his credit. On this resulting balance he will at once draw his demand draft and sell it in the open market. If, from selling this demand draft, he can realize more dollars than it cost him in dollars to put the balance over there, he has made a gross profit of the difference.

To illustrate more specifically: A banker has bought, say, a £1,000 ninety days' sight prime draft, on London, documents deliverable on acceptance. This he has remitted to his foreign correspondent, and his foreign correspondent has had it stamped with the required "bill-stamp," has had it discounted, and after having taken his commission out of the proceeds, has had them placed to the credit of the American bank. In all this process the bill has lost weight. It arrived in London as £1,000, but after commissions, bill-stamps and ninety-three days' discount have been taken out of it, the amount is reduced well below £1,000. The net proceeds going to make up the balance on which the American banker can draw his draft are, perhaps, not over £990. He paid so-and-so many dollars for the £1,000 ninety-day bill, originally. If he can realize that many dollars by selling a demand draft for £990 he is even on the transaction.

No attempt will be made in this little book to present the tables by which foreign exchange bankers figure out profit possibilities in operations of this kind. The terms obtainable from foreign correspondents vary so widely according to the standing and credit of the house on this side and are governed by so many different influences that a manager must work out each transaction he enters according to the conditions by which he, particularly, and his operations are governed. Such calculations, moreover, are all built up along the general line of the scheme presented below:

Assume that the rate for demand bills is 4.85, that discount in London is 3-1/2 per cent, and that the amount of the long bill remitted for discount and credit of proceeds is £100.

The various expenses are as follows: