Since the drawee bank is a well-known institution abroad, and since the traveler has attested authority to draw with assur ance of acceptance and a list of agents who will purchase the drafts drawn, he finds little difficulty in providing himself vvith cash en route. If, for instance, the traveler called on the Madrid correspondent and asked to be paid the equivalent of £ioo sterling, the Madrid bank would draw up a sterling draft for £ioo and specify thereon that it was drawn under Letter of Credit Number , issued by a named bank on a named date. The traveler would be asked to sign the draft, and his signature would be compared with the signature in the letter; if approved, the Madrid bank would then pay the traveler the equivalent of £ioo in pesetas and would reimburse itself by sending the draft to Be for collection and credit. As soon as Ba issues a letter of credit it advises Be and sends a specimen of the drawer's signature to be used by Be to determine the genuineness of the drafts pur porting to be drawn under the credit. If the drafts are genuine, Be will credit the Madrid bank's account and debit Ba's, and forward the draft to Ba. Upon receipt Ba will reimburse itself according to the terms under which the letter was issued, nor mally at the selling rate of exchange for banker's demand bills on London plus commission and interest for 3o days at current rates.
Dollar Drafts and Credits The illustrations given above of commercial and travelers' credits refer to sterling credits, and the drafts drawn under them are assumed to be in sterling. In recent years there has been a marked growth of dollar credits. The drafts drawn under these are dollar drafts, the accepting being done by American banks. The power of national banks to accept drafts drawn on them was first conferred in 1913. Up to that time what small accepting was done was by private bankers, state banks, and trust com panies. Dollar exchange and dollar acceptances are developing fast, much to the advantage of American traders. If, for ex ample, Ie has established a dollar credit with Ba, Ea can draw in dollars, thus eliminating fluctuations in exchange rates as a factor to be calculated in the price quoted by Ea to Ie. Ea is sure of his price, as the exchange risk is shifted to Ie. Ia also eliminates one commission charge on a letter of credit, for both Ba and Be draw commissions under the sterling credits, whereas only Ba draws a commission under dollar credits. Still another advan tage of dollar credits is that it reduces the number of currency conversions; for instance, if a shipment of coffee be made from Brazil under sterling credits, milreis have to be converted into pounds sterling at a rate of exchange, and sterling into dollars at a rate of exchange, whereas under dollar credits the conversion from milreis is to dollars directly.
Short-Term Loans Bankers take advantage of cheap money in one market and dear money in another by borrowing in the one and loaning in the other. The operations by which these short-term loans are effected through the foreign exchanges are of two general types: (1) the sterling, franc, or mark loan, and (2) the currency or dollar loan, as they are called.
In loans of the former type the lending bank receives a com mission, and the borrower bears the risk of exchange rate fluctua tions. Although Be is named the "lending" bank, it will appear below that Be does not lend; the loan is simply effected by means of it. The operation of a sterling loan is as follows: Suppose Be, because money rates are low in London and high in New York, decides to place a loan in New York. Be instructs Ba to draw bills on it for, say, £4o,000 at 6o days; the bills are turned over to a brokerage house against good collateral pledged with Ba; the brokerage house sells the bills at their best price, say, $153,2oo. The buyers, Da, send them to their London agent to have them accepted, and then either hold them till their maturity or sell them to De. Or else the brokerage firm itself sends them to its London agent to have them accepted and then sold direcdy to De. In either case the actual creditor is De, for neither Ba nor Be have put up any money; both have simply put their names to a credit instrument. The understanding is that Be is to receive a com mission of, say, 3/8 per cent, of which Be allows Ba a part, say, 1/8 per cent.
About ten days before the maturity of the 6o's the brokerage house hands Ba a demand draft on London for £40,150 (£4o,000 plus 3/8 per cent of £4o,000 commission), which draft it has to buy at the demand rate prevailing in New York. Meanwhile the brokerage house has had the use of $153,2oo for 5o days, and whether or not the sterling loan proves a profitable operation to it depends upon what it has to pay for the demand draft. If the exchange rates have fallen and it can buy a demand draft for $153,5oo, the use of $153,2oo will cost only $3oo; but if the rates have risen greatly the loan may prove costly. The risk of ex change falls therefore on the American borrower, and the cost of the use of the funds cannot properly be considered as interest. Be and Ba get commissions. Be would prefer loans of this char acter if it expected a rise of exchange rates. The demand draft is sent by Ba to Be to cover the 6o's when they mature, and Ba looks to Be for his share of the commission, $5o.