In loans of the currency or dollar type the lending bank bears the risk of exchange rate fluctuations and the borrower receives his loan in dollars. In this type Ba draws, as above, on Be for 6o days for £4o,000 but, instead of handing the bills to the bor rower, sells them to Da and loans the proceeds to the borrower for about 5o days at the prevailing market money rate. Da sends the bill to London, has it accepted, and sells it to De; and De becomes the real creditor in the transaction, for neither Da nor Ba nor Be is out of any actual funds; Ba has simply loaned what he received for the bill from Da, Da recouped from De, and Be has promised to pay later at maturity. Da was creditor for about io days, or until he sold to De. At maturity of the loan Ba will receive its face value from the borrower; about lo days before maturity of the 6o's Ba buys a demand draft for as big an amount sterling as he can get with the money received from the borrower, less Ba's commission. The excess of the face of this draft over £4o,000 represents the profits of the loan to Be; of course, if exchange rates have risen greatly, there may be a loss. Be, therefore, prefers currency loans to sterling loans when he expects a fall in exchange rates.
It may appear that, since De is the ultimate creditor in both types of loan, Be may extend operations of this kind indefinitely. In currency loans the risk of exchange fluctuations may restrain Be; but against this risk he may hedge by buying for delivery in 6o days a demand draft, for £4o,000. The real restraint comes from the impossibility of selling drafts on Be in the London dis count market except at such sacrifice prices as would ruin his credit. If too many loan bills are accepted by him the market becomes suspicious and the Bank of England refuses to redis count his bills. This puts a limit to further profitable loaning in New York.
Currency and sterling (franc, mark, etc.) loans tend to stabi lize exchange rates from season to season and to minimize gold shipments. If surplus funds with low interest rates and low exchange rates prevail in London, but tight money with high interest and exchange rates exists in New York, Be will strive to place currency loans to take advantage both of the present high interest rates and the expected fall of exchange rates in New York. But this operation itself adds to the present supply of ex change in New York, and will add to the future demand for ex change there when sight bills to cover are bought, and therefore tends to reduce the present high exchange rate and will tend to raise the prospective low rate. The operation is primarily a short
sale of exchange in the guise of a loan.
Finance Bills—Stock Exchange Operations The term "finance bill" is applied to long bills drawn by one banker on another to raise money for the use of one or the other, or of both. Finance bills are said by some writers to differ from loan bills described above, in that loan bills are drawn to raise money to lend to third parties against collateral security. This distinction is not clear-cut; nor does the finance bill differ in appearance from the loan bill. Banker's long bills drawn to recover funds already invested in documentary bills are not commonly classed as finance bills. A finance bill issued and sold in New York makes the New York purchaser finance the opera tion; but in practice this financing is usually shifted at once by Da to De on the London discount market.
Various conditions lead to the issue of finance bills, the chief among which are stock exchange operations and foreign ex change speculations. By far the greater number are drawn in sterling on London. Finance bills are drawn on branches or correspondents.
Sterling finance bills are long bills drawn by Ba on Be, at such times as Ba wishes to raise money to finance some operation in behalf of himself or of Be or of both. If done on B a's account alone, Be is paid a fee or commission for accepting such drafts; if done for joint account, the profits from the transaction are divided on a prearranged basis. In any case the bills drawn are sold by Ba to Da, who sends them to London, has them ac cepted, and either holds them until maturity or sells them to De in the London discount market. The real creditor in this trans action is De. Finance bills are often secured by collateral; whether or not they are so secured, and what securities, if any, are provided, are matters of negotiation between B a and Be; Be may undertake to accept the drawing of Ba without security because of Ba's high credit rating.
The common occasions for the use of finance bills are enumerated below: 1. Ba may find the difference in interest rates in New York and London to be wide enough to permit borrowing in London and lending in New York and more than cover the incidental expenses. He secures permission from Be to draw long bills, raise the money (which ultimately comes from De), and put out the loan. This operation is similar to the loan bill, except that the loan bill arose through Be's initiative. Ba will likely hedge by buying a contract for the future delivery of demand or cable bills sufficient to cover Be's obligation in the acceptance.