A would thus be in a position to sell his demand draft for the above amount and provide himself with funds in New York, £9,943.22 at $4.88=$48,522.90, the same amount as realized in (1) by the sale of the sixty-days bill itself in New York.
The net proceeds, $9,943.22, are taken as the amount of the demand draft for illustrative purposes ; in actual practice the draft would have been drawn in If, at the maturity Of a finance bill, it is not con venient to collect and remit the relative loan, it is gen erally possible to provide the necessary funds to meet the maturing bill by the sale of another bill.
4. Loan of a finance last example shows that the New York banker assumes the risk of there being a rise in the rate of exchange before the trans action has been completed and the acceptance in Lon don retired by a sterling remittance.
So far as the actual borrower is aware, the loan is an ordinary loan in American currency; he has no means of knowing that there is any question of for eign exchange connected with the transaction. He has borrowed, say, $50,000 at two months at 4 per cent, but with his bank the case is different. It has loaned the proceeds of a sixty-days bill on London and at its maturity will have to purchase a demand bill or cable for £10,000 at the current rate of exchange. The price paid for the bill will determine the gain or loss in the transaction. If exchange rates have gone down as anticipated a good profit on the transaction may be made, but if, on the other hand, the rate has risen, the price which is to be paid will mean a loss in the transaction, if it will not wipe out all the profit.
Bank A can eliminate this risk by loaning the bill of exchange instead of the dollar proceeds, and charg ing a commission instead of a fixed rate of interest; the borrower this assuming the risk of a rise in the exchange rate. The borrower in this case, instead of receiving a loan of $50,000, would be handed A's sixty-days draft on London for 10,000. This, he would immediately sell for dollars, but when the time for repayment came, he would have to pay back not dollars but a demand draft for £10,000 which he would have to purchase at the current rate of ex change. The banker makes a commission of about one-half of one per cent for sixty days and runs no risk in the matter other than the loaning risk to his customer.
5. A finance bill on London form of finance bill is created when a London banker, desirous of taking advantage of a high rate of interest in New York, instructs his correspondent to draw on him for £10,000 at sixty days and lend the proceeds on the New York market. This the New York banker does and sells the bill in New York, investing the money. Neither banker employs his own money in the operation, the money being provided by the London market where the bill is discounted. At the maturity of the loan, the London bank is placed in funds to meet its acceptance by the New York banker, or if conditions continue favorable the amount may be either renewed or reloaned in New York. A trans action of this nature may be entirely on the account of and at the risk of the London banker, or it may be on joint account, in which case both the risk and the profit are shared.
6. Other uses of _finance bills, both secured and unsecured, may be drawn regardless of the conditions of interest or exchange, purely for the sake of raising money. As a rule, finance bills have a reasonable excuse for their existence. It may be objected that this is a way of getting money which might be easily abused, but in practice this does not happen. The London market is, at all times, uncan nily in touch with the position of both the drawer and acceptor and any attempt on the part of either to issue this class of bill beyond what he is legitimately entitled to on the basis of his business or financial standing, is promptly nipped in the bud, first, by demanding higher rates and finally, by refusing to take the paper. Either action is, of course, detrimental to the credit of the party concerned, and bankers and others who operate in finance bills are most careful to leave a large margin for safety in their use of the very sensitive dis count market. It is plain from the above explana tions that when many of these finance bills are drawn on London they will have a tendency to lower the rate of exchange by increasing the supply of sterling bills on the market.