The two principal instruments of commercial credit, apart from book accounts, are the promissory note and the bill of exchange. A promissory note is a written promise to pay a certain sum of money to the payee on demand or at the end of a definite time. The payee, by indorsing it, may make it payable to a third person, and he in turn may transfer it to a fourth person, and so on. Each indorser makes himself responsible in case the maker of the note fails to pay it when due. In most lines of business the interval between buying and selling stocks of goods necessitates borrowing from the banks. Though the practice of giving promissory notes to cover purchases of goods has declined in this country, it is still common in certain lines of business. Such paper when indorsed by the payee can readily be exchanged for bank credit by being discounted at the. bank. It is believed that under the Federal Reserve Act, which provides for the rediscount of commercial paper held by the banks, the promissory note as a medium of payment will regain some of its former popularity.
Form of Promissory Note.
Sometimes firms have such high credit that they can borrow by offering their own notes for discount. Such notes are known as "single-name paper." If the firm secures the indorsement of some other person or firm, the paper is called "double-name' or "indorsed' paper. When such indorsement is made simply as a favor or an accommodation, and not in consequence of an actual business transaction, the note is called "accommodation paper." Though the accommodation indorser is responsible to a third innocent party in case the original maker fails to pay the note, this class of paper is not highly regarded in banking circles. When a borrower pledges stocks, bonds, or other evidences of property, to add to the personal security of his note, the paper is known as a "collateral note." If a collateral note is not paid when it falls due the bank may sell the securities and reimburse itself from the proceeds. Call loans, that is, loans payable at any time on the demand of either lender or borrower, are usually based on collateral security consisting of stocks and bonds. Such loans are confined largely to stock exchange brokers who are dealing constantly in securities.
A bill of exchange is a written order by one person to another requesting payment of a definite sum of money. Bills of exchange are of two general classes: foreign and domestic. Legally, a "foreign" bill of exchange is one drawn upon someone living in another state from that of the drawer. In everyday business, however, a foreign bill means one drawn upon someone in a foreign country.1 Domestic bills of exchange, or "drafts," as they are generally called, are either "sight' or "time" drafts. A sight draft is payable on demand; a time draft is payable a certain time after sight or date. The party drawing the bill is called the "drawer" and the person on whom it is drawn, the "drawee."
The following simple illustration will show the use of the commercial draft. Meyer and Co. of Pittsburgh order a bill of goods from J. B. Arnold of New York, and state in their order that upon receipt of the goods in good condition they will "honor" a draft at thirty days' sight for the amount. Arnold draws a sight draft, payable to himself, and after indorsing it he deposits it in his bank. The bank forwards it at once to its correspondent bank in Pittsburgh. As soon as possible after its receipt by the latter, the draft is .sent by a runner to the office of Meyer and Co. They honor or "accept" the draft by writing across its face the word "accepted," with the date, the name of the bank where they wish to make payment, and their signature. The draft is now known as an "acceptance*/ and is in effect a promissory note. Upon notice from the Pittsburgh bank that the draft has been accepted, Arnold's bank in New York discounts the acceptance and credits his account with the proceeds. If the bank has confidence in Arnold's responsibility it may discount his draft as soon as he deposits it. Meyer and Co. pay the draft at their bank or office when it matures and settlement is made between the Pittsburgh and New York banks, thus completing the transaction. Instead of making the draft payable to himself, Arnold may draw in favor of a third party to whom he owes money. This is known as a 'three-party' draft, but the procedure in presentation and payment is essentially the same as in the case of the "two-party" draft. A sight draft is payable on presentation. Sometimes the drawee, instead of paying the draft when presented at his office, accepts it, making it payable at his bank. It then becomes practically a check, and the runner goes to the bank designated by the acceptor to collect it. The principles involved in the use of foreign bills of exchange are substantially the same as in domestic bills.
1 For a full explanation of foreign bills of exchange, see Chapter XVII (Bank Supervision. 140. Reports And Examinations).
No Proust Tear This Off Before Presenting.
Bills of exchange are frequently accompanied by bills of lading, or other evidences of property. For example, in the foregoing transaction between Arnold and Meyer and Co., Arnold upon shipping the goods at New York receives from the railway company a bill of lading which is an acknowledgment of the receipt of the goods and a contract for their delivery in Pittsburgh. The bill of lading is attached to the draft, together with the invoice of the goods, and the papers are forwarded through the banks as already described. In order to get possession of the bill of lading entitling them to the goods, Meyer and Co. of Pittsburgh must accept the draft or pay it if it is a sight draft. Generally, banks are more ready to advance loans on drafts accompanied by bills of lading than on paper resting on personal security alone. Despite its evident safety and convenience as an instrument of credit, the bill of exchange is not as widely employed in this country as in England, where it has attained the highest degree of acceptability.
As an instrument of credit and of exchange the warehouse receipt performs much the same function as the bill of lading. A warehouse receipt is a receipt for grain, cotton, or other merchandise stored in a warehouse. It is a negotiable instrument and passes from hand to hand by indorsement like a promissory note or a check. As grain, cotton, and other staple warehouse products are now carefully classified and standardized, warehouse receipts arc largely used as collateral for procuring loans at the banks.