Before taking up the question of the activities of the foreign exchange department and the question of how bankers make money dealing in exchange, it may be well to fix in mind clearly what the various forms of foreign exchange are. Following is a description of the most important classes of bills bought and sold in the New York market:

1. Commercial Long Bills

Drafts drawn by shippers of merchandise upon buyers abroad, or upon the banking representatives of the buyers abroad, at thirty days' sight or more. The drafts may be accompanied by shipping documents or may be "clean." The former kind of bill making up the greater part of the whole amount of foreign exchange dealt in in the New York market, will be described first.

Suppose a cotton dealer in Memphis to have sold one hundred bales of cotton to a spinner in Liverpool, the arrangement being that the English buyer is to be drawn on at sixty days' sight. The first thing the Memphis merchant does is to ship the cotton on its way to Liverpool, receiving from the railroad company a receipt known as a "bill of lading." At the same time he arranges for the insurance of the cotton, receiving from the insurance company a little certificate stating that the insurance has been effected.

The next step is for the Memphis shipper to draw the draft on the Liverpool buyer—‌or upon some bank abroad designated by the buyer. This draft is drawn in pounds sterling for the equivalent of the dollar value of the cotton and made payable sixty days after the party abroad on whom it is drawn has seen it and written "accepted" across its face. This draft, the bill of lading received from the shipping company, and the insurance certificate received from the insurance company are then pinned together and constitute a complete "commercial long bill with documents attached."

Other less important documents go with such a bill. Sometimes invoices showing the weight and price of the cotton go along with it and sometimes there is also attached a "hypothecation slip" which formally turns over the right to the goods to the Memphis or New York banker who buys the draft and accompanying documents from the Memphis cotton shipper. Sometimes, too, insurance is effected by the buyer abroad, in which case there may be no insurance certificate. But in the main, one of these "documentary" commercial bills consists of the draft itself, the bill of lading, and an insurance certificate.

Having pinned the document and the draft together, the Memphis cotton shipper is in possession of an instrument which he can dispose of for dollars. This he does either by selling it to his bank in Memphis or by sending it to New York, in order that it may be sold there in the exchange market at the current rate of exchange. Say, the bill of exchange is drawn on London at sixty days' sight, for £1,000. The buying price for such a draft will be, perhaps, 4.84. The Memphis shipper gets his check for $4,840, and is out of the transaction. The bill has passed into a banker's hands, who will send it abroad—‌deposit it in some foreign bank where he keeps a balance.

As to the rate of 4.84 received by the shipper, it is to be noted that had the bill been drawn at less than sixty days' sight, he would have received more dollars for it, while if it had been drawn at more than sixty days' sight, he would have received less for it. The longer the banker who takes the draft off the shipper's hands has to wait until he can get his money back on it, the lower, naturally, the rate of exchange he is willing to pay. On the same day that demand drafts are selling at 4.87, sixty-day drafts may be selling at 4.84 and ninety-day drafts at 4.83.

Assume, in this particular case, that the draft has been taken off the shipper's hands by some foreign exchange banker in New York. By the very first steamer the latter will forward it to his banking correspondent abroad, with instructions to present it at once to the parties on whom it is drawn, in order that they may mark it "accepted—‌payable such-and-such-a-date." After that the bill is a double obligation of the drawer and the drawee, and may be discounted in the open market, for cash.

Just here it is necessary to digress and state that documentary commercial bills are of two kinds—‌"acceptance" bills and "payment" bills. In the case of the first-named, the documents are delivered to the party on whom the bill is drawn as soon as he "accepts" the bill, which puts him in a position to get possession of the merchandise at once. In the case of a "payment" bill, the credit of the man on whom it is drawn is not good enough to entitle him to such a privilege, and the only way he can get actual possession of the goods is to actually pay the draft under a rebate-of-interest arrangement. All bills drawn on banks are naturally "acceptance" bills; and being discountable and thus immediately convertible into cash abroad, command a better rate of exchange in the New York market than "payment" bills, which may be allowed to run all the way to maturity before a single pound sterling is paid on them.

Except in the case of the shipment of perishable merchandise—‌grain shipped in bulk, for instance. In that case the buyer on the other side cannot afford to let the draft run, because the merchandise would spoil. He is simply forced to pay it under rebate, in order to get possession of the grain. And the rebate being always less than the discount rate, less pounds sterling come off the face of the bill in the process of rebating than of discounting. For which reason sixty-day bills drawn against shipments of grain—‌documents deliverable only on payment under rebate—‌command a better rate of exchange even than the very best of cotton "acceptance" bills drawn on banks.

2. Clean Bills

Where the drafts of the merchants of one country drawn upon the merchants or bankers of another are unaccompanied by shipping documents they are said to be "clean." Bills of this kind may originate from the transfer of capital from one country to another or may represent drawings against shipments of merchandise previously made. It is not unusual, indeed, where the relationship between some foreign merchant and some American merchant is very close, for the one to ship merchandise to the other without drawing drafts against the shipment until some little time afterward. It might happen, for instance, that a cotton manufacturing firm in France wanted to import a lot of raw cotton from the United States, but did not want to be drawn upon at the time. Under such circumstances the American house might ship the goods and send over the documents to the buyer, postponing its drawing for some time. Eventually, of course, the American house would reimburse itself by drawing, but the documents having gone forward long before, the drafts would be what is known as "clean."

Later on, in the chapter on the actual money-making operations of the foreign department, the risk in buying various kinds of bills will be fully explained, but in passing it may be mentioned that "clean" bills are of such a nature that bankers will touch them only when drawn by the very best houses. With a documentary bill, the banker holds the bill of lading, and if there is any trouble about the acceptance or payment of a draft, can simply seize the goods and sell them. But in the case of a "clean" bill, he has absolutely no security. The standing of the maker of the bill and what he knows about the maker's right to draw the bill is all he has to go by in determining whether to buy it or not.

3. Documentary Commercial Bills Drawn at Short Sight

A comparatively small part of our exports are sold on a basis where the draft drawn is at less than thirty days' sight, but there are a good many small bills of this kind continually coming into the market. Drafts drawn against manufactured articles and against such products as cheese, butter, dried fruits, etc., are apt to be drawn for, with shipping documents attached, at anywhere from three to thirty days' sight, but there is no rule about it. Where the "usance"—‌the time the bill has to run—‌is only a few days, documents are apt to be deliverable only on payment of the bills.

4. Drafts Drawn Against Securities

Exchange of this kind is naturally of the highest class, the stocks or bonds against which it is drawn being almost always attached to the bill of exchange. In the case of syndicate participations by large houses, the bonds may be shipped abroad privately and exchange against them drawn and sold independently, in which case, of course, no security is attached, but as a rule the bonds or stocks go with the draft. A, in New York, executes an order to buy for B in London, one hundred Union Pacific preferred shares on the New York Stock Exchange. The stock comes into A's office, and he pays for it with the proceeds of a sterling draft he draws on B. The stock itself he attaches to this sterling draft. Whoever buys the draft of him gets the stock with it and keeps possession of it till the draft is presented and paid in London.

5. Bankers' Checks or Demand Drafts on Their Correspondents Abroad

Bankers who do a foreign exchange business, keeping large balances in several European centers, are continually drawing and selling their demand drafts—‌"checks," they are called, or "demand"—‌upon these foreign balances. Such checks are always to be had in great volume in the exchange market, the banker's business being to draw and sell exchange, and his degree of willingness being merely a matter of rate. There come times, of course, when bankers have every reason to leave their foreign balances undisturbed, but even at such times the bid of a high enough rate will usually bring about the drawing of bills.

6. Bankers' Long Drafts

In describing the nature of bankers' drawings of long bills, great care must be taken to differentiate between the different kinds of long bills being bought and sold in the exchange market. A finance bill looks exactly the same as a long bill drawn by a banker for a commercial customer who wants to anticipate the payment abroad for an incoming shipment of wool or shellac, but the nature and origin of the two bills are radically different. The three main kinds of bankers' long bills will thus be taken up in the following order:

A. Bills Drawn in the Regular Course of Business

Such is the nature of foreign exchange business that bankers engaged in it are continually drawing their sixty and ninety days' sight bills in response to their own and their customers' needs. One example which might be cited is that of the importer who has a payment to make on the other side, sixty days from now, but who, having the money on hand, wants to make it at once. Under some circumstances such an importer might remit a demand draft on the basis of receiving a rebate of interest for the unexpired sixty days, but more likely he would go to a banker and buy from him a sixty days' sight draft for the exact amount of pounds he owed. The cost of such a draft—‌which would mature at the time the debt became due—‌would be less than the cost of a demand draft, the importer getting his rebate of interest out of the cheaper price he pays for the pounds he needs. Prepayments of this sort are responsible every day for very large drawings of bankers' long bills.

B. Long Bills Issued in the Operation of Lending Foreign Money

Bills of this kind represent by far the greater proportion of bankers' long bills sold in the exchange market. European bankers keep an enormous amount of floating capital loaned out in this market, in the making and renewing of which loans long bills are created as follows:

A banker on the other side decides to loan out, say, £100,000 in the New York market. Arrangements having been made, he cables his New York representative to draw ninety days' sight drafts on him for £100,000, the proceeds of which drafts are then loaned out for account of the foreign house. The matter of collateral, risk of exchange and, indeed, all the other detail, will be fully described in the succeeding chapters on how bankers make money out of exchange. For the time being it is merely necessary to note that every time a loan of foreign capital is made here—‌and there are days when millions of pounds are so loaned out—‌bankers' long bills for the full amount of the loans are created and find their way into the exchange market.

C. Bankers' Long Bills Drawn for the Purpose of Raising Money

Finance bills constitute the third kind of bankers' long exchange. In this case, again, detailed discussion must be put off until the chapter on foreign-exchange-bankers' operations, but the fact that bills of this kind constitute so important a part of the bankers' long bills to be had in the market, necessitates their classification in this place. Every time a banker here starts to use his credit abroad for the purpose of raising money—‌and there are times when the privilege is pretty freely availed of—‌he does it by drawing sixty or ninety days' sight drafts on his correspondents abroad. Finance bills, it may be said without question, are one of the most interesting forms of foreign exchange banking—‌at the same time one of the most useful and one of the most abused of privileges coming to the domestic banker by reason of his having strong banking connections abroad.