Bond houses doing an international business are therefore keenly watchful of the maturity of issues largely held abroad, and are ever ready with offers of new and attractive investments. Knowledge of the location of American investments in Europe is thus a business asset of the greatest importance, and records are carefully kept. The fact that a dealer here knows that some bank in London has a wealthy client who holds a big block of certain bonds about to mature, may very possibly mean that the house here may be able to make a very profitable trade. Information of this character is carefully gathered wherever possible and as carefully guarded. The longer a house has been in business, naturally, and the closer its financial relationship with investment interests abroad, the more of this sort of information it is bound to possess.
Foreign exchange growing out of these renewals and refundings is on a very large scale. Sometimes the placing of a new issue abroad means such immediate drawing of drafts on foreign buyers of the securities as to depress the exchange market sharply. Sometimes, as in the case of new issues of railroad stock, where payments are usually made in instalments covering a year or more, the drawing of exchange is distributed in such a way that its influence, if felt at all, is felt merely as an underlying element of weakness.
Of a somewhat different character are the foreign exchange transactions originating from what might be called Europe's "floating" investment in American securities and from the out-and-out speculations carried on in this market by the foreigners.
There is never a time, probably, when the floating foreign investment in American stocks and bonds does not run up with the hundreds of millions of dollars. "Speculation," such operations would probably be called by many people, but whether speculation or not, a form of activity which is continually giving rise to big dealings in foreign exchange. For this "floating" investment is very largely for account of bankers whose international connections and credit make it possible for them to carry stocks and bonds through the agency of the exchange market, and without having to put up any actual money. The ingenious method by which this is accomplished is about as follows:
A banker here, for instance, decides that a certain low-priced bond is cheap and that if purchased it will show a substantial profit within six months or a year. Not wanting to buy the bonds and borrow on them here, he invites his foreign correspondent into the deal on joint account, arranging to raise the money with which to buy the bonds by drawing a ninety-day sight draft on the foreign correspondent. This he does, drawing, say, a £50,000 draft at ninety days' sight, and selling it in the exchange market at, let us say, $4.83.
The $241,500 received from the sale of the draft, the American banker uses to buy the bonds. Ninety days later the draft will come due in London, and have to be covered (or renewed) from this side, but in the meantime, a profitable chance to sell the bonds may present itself. If not, the draft can be "renewed" at the end of the ninety days, and again and again if necessary, until the bankers are willing to close out the bonds.
This operation of "renewing" long drafts drawn for the purpose of carrying securities is one of the most interesting phases of foreign exchange business in connection with international security dealings. The draft has been drawn, say, for £50,000. The end of the ninety-day period comes, the draft is due, is presented, and has to be paid. But the bankers do not choose to sell out the bonds and close the deal. They arrange instead to renew the maturing draft. This they do by paying the original ninety-day draft out of the proceeds of a new ninety-day draft.
The original draft for £50,000 comes due let us say on October 19, so that about October 10th the New York banker will be under the necessity of sending over to London a demand draft for £50,000. The rate realizable for ninety-day drafts being always considerably lower than the price of demand drafts, it follows that if the banker proposes to buy £50,000 of demand out of the proceeds of a fresh ninety-day bill he will have to draw his fresh bill for more than £50,000. If the demand rate happened to be 4.86, the £50,000 he needs would cost him $243,000. In order to raise $243,000 by selling a ninety-days' sight draft (say at 4.83) he would have to make the new draft for £50,310. The extra £310 would constitute the interest. Each time he renewed the draft he would have to draw for more and more.
Requiring the tying up of no actual capital, this form of financing "floating investments" has become exceedingly popular and is carried on on a large scale. Where the relationships between the foreign and the American houses are close, there is almost no limit to the number of times an original bill may be renewed. As for the constantly increasing amount of the drafts which have to be drawn, that is taken care of by the interest on the investment carried.
Not all the floating investment in American securities is carried in this way, but in whatever form the financing is done it is bound to involve foreign exchange operations and to necessitate the drawing of drafts by banking houses in this country on their correspondents abroad. Quiet conditions may result in long periods when investments of this kind are left undisturbed, but even then, the constant remitting and renewing of drafts originates a good deal of exchange market activity. And with considerable frequency occur periods when the floating investment is strongly affected by immediate conditions, and when purchases, sales, and transfers of securities stir the exchange market to a high pitch of excitement.