4. What makes the rate.—The rates of exchange quoted between any two countries, therefore, are the prices for checks and bills of exchange. These are the mediums by which debts are transferred from one party to another.
The rate of exchange charged by a bank or broker for a foreign bill of exchange includes: 1. The mint par or price equivalent of the foreign coin.
2. Plus or minus a premium or discount on the mint par (greater or less conversely to the supply of bills on the market as compared with the demand for them).
3. Plus a premium or commission which the banker de mands for his trouble and for the economy and superior con venience of a draft as compared with a remittance in coin or bullion.
4. Less an allowance for interest, according to the distance between the two points, and the tenor of the draft.
5. Plus the cost of shipping gold.
The rate of exchange paid by a bank or broker for a foreign bill of exchange includes: 1. The mint par.
2. Plus or minus a premium or discount on the mint par.
3. Less a commission covering the dealer's profit and an allowance for his risk and trouble.
4. Less a discount, according to the tenor of the draft.
5. Minus the cost of shipping gold.
The mint par never varies. It is a constant factor in any exchange rate. The most frequent variations in the rates arc found in the premium or discount on the mint par, the range of which is governed by the law of supply and demand, and reflects the relative position of two countries as regards in debtedness. The allowance for interest or discount generally tends to vary with the foreign interest rate, tho sometimes in large transactions the domestic interest rate becomes a factor also, in connection with the financial operations necessary to complete them. The cost of shipping gold is modified and at times offset by the mutations in the other factors.
5. Coinage rate of exchange, therefore, must not be confused with the ratio at which one country will exchange its money for the standard coins of another country. If a man has one thousand sov ereigns in New York he will receive par for them, or $4,866.56 1 irrespective of the rate of exchange.
6. Fluctuation in the rate of in termediate rates between the gold points and the mint par, that is, the rates at which business is usually done, in addition to being affected by the supply and de mand of bills between two places, rise and fall in sympathy with the influences at work on the other ex changes. New York, for instance, whilst a debtor to England, may be a creditor of Germany, France or another country with which England has close ex change relations. New York drafts on these places are remitted to London and improve (i. e. lower) the rate of sterling exchange for the time being. If, however, the supply both of London and Continental bills falls short, the point at which New York will have to export gold is soon reached.
7. Bates tend to correspond.—The rates of ex change between two or more places either correspond or tend to correspond. Thus, when sterling exchange is at a discount in New York, say, at $4.85, New York funds in London will be at a premium; in other words, you could purchase in New York the right to obtain a sovereign in London for $4.85, whereas for a sov ereign in London you would only be able to obtain the right to $4.85 in New York, a dollar costing 49.50d. instead of 49.316d., the par value.
Let us suppose that the rate in New York, in re sponse to a demand for sterling, suddenly goes to par, and a New York banker, hearing from his London correspondent that New York funds are still at $4.85, cables him to sell $100,000 at that rate and as a result of this transaction the New York banker receives a credit in London of £20,618.55. At the same time he sells his own draft at par against this amount in Lon don. In actual practice he would sell a draft of, say, £20,000, but for the sake of showing his profit let us presume that he sold a draft for £20,618.55. For this he receives $100,343.64 with which he pays the draft of $100,000 drawn on him in London, and thus makes a profit of $343.64 less cable charges and a small commission to the London banker.