The Money Market

by F. Straker

Except when otherwise stated, the rates quoted in the “Course” are for bills having three months to run, or in technical language, they are the rates for the “Long exchange.” Rates quoted as “cheque,” “sight,” or “demand,” are known as the “Short exchange.”

The rates of the Long exchange are arrived at as follows: We will suppose that a merchant in London has to pay a debt in Paris of 25,000 francs, and for simplicity we will assume that the sight rate on Paris is 25. If the merchant buys a sight draft on Paris for 25,000 francs and remits it to his creditor, it closes the transaction, and the remittance has cost the merchant £1,000.

But if instead of buying a sight draft at this rate he bought a three months draft, what would be the result? When he sent this draft to his friends in Paris they could not credit him with it at once, and so close the transaction, as they would then be out of their money for three months. So the parties in Paris to whom the draft was remitted would discount it with their banker, and credit the London merchant with the proceeds only. He would also be charged for a bill stamp, and in addition, he would be liable for any contingencies which might arise, interfering with the due payment of the bill, until payment was actually made. So instead of the London merchant being credited with 25,000 francs, he would only be credited with 25,000 francs minus discount at the French market rate, say 4 per cent. for three months = 250 francs, and minus the bill stamp = 12·5 francs, that is 24,737·5 francs. Moreover, he would be under liability on his endorsement of the draft until its maturity, and for this he ought to receive some consideration. Consequently when the London merchant buys his bill, if a three months bill is offered him instead of a sight draft, he demands an allowance in the rate sufficient to cover interest at the foreign market rate, plus stamp, plus allowance for contingencies. And the rate for such a transaction will be arrived at as follows: First, as the presumed sight rate is 25, to this must be added three months’ interest at the foreign market rate (say at 4 per cent.) on 25, which is ·25, bill stamp at ½ per mille must also be added, say ·01¼, and an allowance for risk which we may take at ·00¾. Thus the rate for such a three months draft would be 25 + ·25 + ·01¼ + ·00¾ = 25·27.

Now at this new rate, or “long rate” of 25·27, let us suppose our merchant to buy and remit a draft of 25,270 francs for £1,000. His friends in Paris will then credit him with the full amount of his debt, and a little more, being the allowance for risk.

It must be distinctly borne in mind that adding interest, etc., to the “sight” rate to obtain the “long” rate only holds good when we are dealing with rates quoted in foreign currency, and that when we deal with rates quoted in sterling we must deduct these allowances from the short rate instead of adding them.

It will be noticed that two prices are quoted opposite each centre in the “Course of Exchange.” These prices do not represent the figure at which bills can be bought and sold, like Stock Exchange quotations. As regards the “long” rates, the two prices indicate the price ruling for different classes of paper, bank paper and trade paper. Bank bills will discount abroad at a lower rate than commercial bills, as with us; and therefore in calculating the long exchange on bank bills a smaller amount has to be allowed for interest than with commercial bills. Hence, of these two quotations the lower rate is for bank paper, and the higher rate for trade paper.

As regards the two rates for short quotations, the explanation is that “demand” bills are understood to mean any draft having up to ten days to run. A bill which is not due for ten days is, of course, not worth as much as a draft due at once. The standing of the parties to the draft also affects the quotation to some extent.

There is still to be considered the important question of how the Foreign Exchanges are connected with our Money Market, and how they influence and are influenced by the Bank Rate and the value of money in England.

It is evident that if the market rate of discount for first-class paper is higher in London than in Paris, a French banker will earn more interest on his money if he buys London bills than if he buys Paris bills. But when dealing with foreign bills, “exchange” comes into the question as well as interest. This further factor introduces an element of speculation which is not present with the home article.

Suppose, for example, the Paris market rate to be 3 per cent. and the London rate 4 per cent.—the cheque exchange standing at 25·22 and the long rate in Paris of bills on London consequently at about 24·97. A banker in Paris buys a three months bill on London for £100, paying for it 2,497 francs. When the bill falls due it can be sold as a sight draft. If the short exchange remains at 25·22 it will realise 2,522 francs, showing 25 francs as the interest for three months on the amount invested, that is at the rate of 4 per cent. per annum, as against 3 per cent. per annum, which is the rate which would have been earned in France for these three months. If when the bill matures the short exchange is, say, 25·12, for the £100 draft the interest will be 15 francs only, or at the rate of 2½ per cent. per annum. On the other hand, if the short rate is 25·32 when the draft matures, the interest will be 35 francs, or about 5½ per cent. per annum.