182. The Sale Of Demand Exchange

Foreign exchange transactions, nowadays, are of considerable scope and endless variety, but all are based fundamentally on five different kinds of operation.

Selling demand exchange and cables against remittances of demand exchange is the elementary principle of the business. Suppose an exporter here to have shipped $5,000 worth of merchandise and to have drawn his draft on the foreign buyer for £1,000. He takes this draft to his banker and sells it at the current rate of exchange, say 485. The latter sends the bill to his correspondent abroad for credit of his account, drawing at the same time his own check for £1,000 against the deposit and endeavoring to sell it at a higher rate than 485. Outside the expense of conducting the business, anything over 485 that he can get for his draft is clear profit. The two transactions cross off. It cost him $4,850 to buy the commercial draft in the first place. By the sale of his own draft he received, say, $4,860. He may not have been out of the use of his money for five minutes, and as to his balance on the other side, the deposit of £1,000 and the draft on the balance for £1,000 arrive by the same mail steamer.

183. Merchant Seller's Credit

Naturally, the credit of a merchant selling a commercial draft enters very largely into the transaction - determines, in fact, what rate the banker is willing to pay him for his bill of exchange. Here, evidently, is a chance for taking risks and making profits. It not infrequently happens that a banker comes to believe that some exporter who is not generally considered strong financially is really all right, and he buys his paper continually, though always at a big reduction from the market for prime bills. Two cents per pound sterling is not infrequently the profit on purchases of exchange of this kind. It is a form of business which a good many bankers refuse to touch at all, but on the other hand there are foreign exchange houses with well-equipped credit organizations who go in largely for just such transactions, and as long as they can avoid the purchase of bad paper they make very large profits. The business, too, can be done with a varying degree of risk, one banker being often in a position to sell his own demand draft at a little better rate than he is offered the demand draft of some other banker. In that case the profit is apt to be small but so is the risk, and an easy chance is afforded to make from one-tenth to one-quarter cent per pound sterling on the amount turned over.

The other form of activity along this line is the selling of "cables" against remittances of demand drafts. A cable transfer works as follows: A in New York has a credit balance in London; B, also in New York, comes to him and says, "I want you to wire your correspondent in London to hand over so-and-so-much in pounds to my correspondent over there. I'll pay you the equivalent on this end." The rate is fixed and A wires to the London bank which holds his money to make the transfer to B's bank, the whole operation being closed inside of twenty-four hours. In point of time we are five hours behind London so that unless the transfer is wired early in the morning it will only take place the following day.