RATES OF INTEREST 1. Interest an important factor in exchange quota tions.—The rate of interest at which the difference be tween long and short bills is calculated is based on the prevailing rate of the country on which the bill is drawn. This would not materially affect the situation if the rates of interest were uniform all over the world, but rates of interest in different financial centers vary considerably and these differences have an important bearing on exchange. Under normal conditions, in ternational money and credit circulate most freely in the most attractive channels, and a rise in the interest rate in a foreign money market will accelerate the flow of outside capital to that point, while a fall in the rate of interest will retard it. So, while demand and sup ply govern rates of exchange, the rates of interest at home and abroad react on these influences and affect demand and supply. Their combined effect causes the rates of exchange to fluctuate from day to day and thus the floating capital of the world is attracted from one center to another.
2. Long bills.—When we say that exchange rates between two countries usually fluctuate between the specie points, we refer only to the rate for demand or sight bills. This is sometimes called the pure rate of exchange as it involves no time element except that re quired for the actual transmission of the draft.
Assuming that the rate at New York for a sight bill or check on London is 4.8725 how would the value of a sixty-days sight bill be ascertained? As payment in the latter case is deferred for sixty-three days (60 days + 3 days grace) it will be worth less than a demand bill by the interest for 63 days at the London rate. The calculation is based on the London rate of interest, because the holder of the bill in London can always discount it at the prevailing rate.
Assuming that the market discount rate for prime bills is 3%, the rate for a sixty-days bill would be ar rived at as follows : Demand rate per 1100.... . . $487.25 Less 63-days interest 2.52
Stamp 1/20 24 2.76 $484.49 corresponding to the nearest commercial rate, the fig ure would be $4.8450.
If, therefore, we know the rate of interest prevailing in foreign markets and the stamp taxes imposed by foreign countries, the rate for any long bill can readily he computed from the demand rate.
3. Bank rate.—In London, the bank rate is the minimum rate at which the Bank of England will dis count prime three months' bills or advance money against approved securities. This rate has a direct relation to the foreign exchange rate and the move ment of gold. An increase in the rate raises the value of money and attracts gold from foreign centers ; the lowering of the rate tends to lower the value of money and causes its withdrawal. The Bank of England sometimes insures the effectiveness of the rate by bor rowing money in the open market, thus denuding it of supplies. The Bank of England is governed in its action in raising or lowering the rate by the relation which its reserve of gold bears to its deposits. This proportion is seldom allowed to fall below 30 per cent, while it sometimes rises above 50 per cent, the average normal condition being about 43 per cent. The im portance of keeping the gold reserve intact is ap preciated and it is most important to the country, as the Bank of England is primarily a bankers' bank and in a great measure controls the gold reserve of all the British banks.
In Paris, the bank rate is that fixed by the Bank of France, in Berlin that of the Imperial Bank. In New York, the bank rate is the uniform rate of the banks as distinguished from the varying rates of the other lenders.
4. Market market rate of discount, also known as the open market rate or private rate, in contradistinction to the official or bank rate, is the rate charged by bankers, bill brokers and others discount ing bills of exchange. Because of competition it is usually a little lower than the bank rate, but as a rule follows the latter very closely.