The buying and selling of foreign bills of exchange is known as trading. In performing this function the banker acts as middleman between those who have bills to sell and those who wish to buy. The banker does not actually resell the identical bill from one party to the other, but sends the purchased bills abroad to be collected by his correspondent, who credits the proceeds to the account of the sender. In buying bills, the banker increases his balance in foreign-money centers and so creates a fund which may be regarded as his supply of foreign exchange. These foreign-exchange balances are reduced through sales of exchange. Thus a purchase of exchange is a credit added to the banker's balance abroad and a sale is a debit.

The orders which a bank receives for buying and selling foreign exchange are executed or filled in various periods of time. A spot delivery necessitates the immediate surrender of the draft by the seller. In the case of a prompt delivery, several days are allowed for completing the delivery. A third type is arranged in what is known as a future, or "forward," contract, which is an agreement by a bank to purchase or sell a certain amount of foreign exchange at a fixed rate for delivery, not at the present time, but on a specified date in the future. The interval between the actual purchase of the exchange and its eventual delivery may extend from several days to several months.

The procedure in selling a future exchange may be illustrated by a typical transaction. For example, in April the American Cotton Exporting Company sells to the British Importing Company a consignment of cotton worth �10,000 for shipment in July. The American firm is unwilling to assume the risk of loss through fluctuation in the value of sterling, and prefers to know exactly what the transaction will be worth in July as expressed in dollars. The American Exporting Company is in possession of a certain amount of future exchange which it desires to sell, and so approaches the banks directly or indirectly through a broker, until it finds a purchaser who accepts the exchange. In July the exporting company ships the cotton, draws a draft on the importer, and delivers the bill with the shipping documents to the bank which has previously agreed to purchase it. The bank examines the draft and documents, compares them with the contract or agreement made in April, and if all conditions have been fulfilled, it pays the exporter for his draft, which is then forwarded abroad. In this transaction the exporter bears only the commercial risk arising from fluctuations in commodity prices; while the banker assumes the exchange risk resulting from the variations in the rates.

The bank is not compelled to carry this risk if it follows a policy of hedging or covering. A cautious bank will so arrange its trading as to make sales and purchases of exchange simultaneously, and, since debits will thus offset credits, its foreign balances will remain stationary. Profits will then be confined to the difference between the selling and the buying rate on bills.

The bank may at times seek larger profits by speculation in exchange, in what is known as "taking a position on the market." A bank may follow a policy of going "long" on the market through buying bills at the prevailing rate and afterward selling them at a profit, provided the rate has risen in the meantime. The "short" side may also be taken by selling bills at the current price in anticipation of a fall in the rate, thus enabling the repurchase of drafts later at a lower quotation. These transactions are the same as the ordinary forms of speculation which seek to obtain profits from differences in prices in the same market at different times.

Another type of foreign-exchange speculation involving comparatively little risk is known as "arbitrage"; it is based on profits which arise from prices quoted in different markets, but quoted all at the same time. As in any other foreign-exchange operation, the aim is to buy at the lowest price and sell at the highest rate. This object is usually accomplished by buying one kind of currency directly with a second, such as francs with dollars. An arbitrage transaction, however, results in a trade indirectly through a third, or intermediary, market. Assume that in New York, on a certain day, the franc is worth 19.25 cents, and the pound sterling $4.86. In London, on the same day, francs are-quoted at 25.25 for one pound sterling. While 2,522 francs in New York cost $486, it would be cheaper to trade in the London market, where $486 (worth �100) will buy 2,525 francs. Thus a profit of three francs would result. When only three markets are involved as in this illustration the transaction is known as a simple arbitrage. A compound arbitrage affects four or more centers. Arbitrage is also used in the investment field. When a security, as United States Steel, is selling at a higher rate in London than in New York, it may be worth while to cable an order to sell shares in London and at the same time cover this transaction through buying an equal amount of the stock on the New York Exchange. Besides securities, the principle of arbitrage may be applied in buying and selling bullion or any other commodity which has a free international market. Arbitrage tends to neutralize wide fluctuations in rates, by eliminating differences in rate, and thus bringing prices near to equality in all markets.